RISK MANAGEMENT AND INSURANCE

UNIT I
What is Risk?
All investments involve some degree of risk. In finance, risk refers to the degree of uncertainty
and/or potential financial loss inherent in an investment decision. In general, as investment risks
rise, investors seek higher returns to compensate themselves for taking such risks.
Every saving and investment product has different risks and returns. Differences include: how
readily investors can get their money when they need it, how fast their money will grow, and how
safe their money will be. In this section, we are going to talk about a number of risks investors
face. They include:
1. Business Risk
With a stock, you are purchasing a piece of ownership in a company. With a bond, you are
loaning money to a company. Returns from both of these investments require that that the
company stays in business. If a company goes bankrupt and its assets are liquidated, common
stockholders are the last in line to share in the proceeds. If there are assets, the company’s
bondholders will be paid first, then holders of preferred stock. If you are a common
stockholder, you get whatever is left, which may be nothing.
If you are purchasing an annuity make sure you consider the financial strength of the insurance
company issuing the annuity. You want to be sure that the company will still be around, and
financially sound, during your payout phase.
2. Volatility Risk
Even when companies aren’t in danger of failing, their stock price may fluctuate up or
down. Large company stocks as a group, for example, have lost money on average about one
out of every three years. Market fluctuations can be unnerving to some investors. A stock’s
price can be affected by factors inside the company, such as a faulty product, or by events the
company has no control over, such as political or market events.
3. Inflation Risk
Inflation is a general upward movement of prices. Inflation reduces purchasing power, which
is a risk for investors receiving a fixed rate of interest. The principal concern for individuals
investing in cash equivalents is that inflation will erode returns.
4. Interest Rate Risk
Interest rate changes can affect a bond’s value. If bonds are held to maturity the investor will
receive the face value, plus interest. If sold before maturity, the bond may be worth more or
less than the face value. Rising interest rates will make newly issued bonds more appealing
to investors because the newer bonds will have a higher rate of interest than older ones. To
sell an older bond with a lower interest rate, you might have to sell it at a discount.
5. Liquidity Risk
This refers to the risk that investors won’t find a market for their securities, potentially
preventing them from buying or selling when they want. This can be the case with the more
complicated investment products. It may also be the case with products that charge a penalty
for early withdrawal or liquidation such as a certificate of deposit (CD).
What Are the Types of Business Risk?
There are many types of business risks. That’s why it’s important to understand how each type of
risk arises. You’ll want to address each one in your risk management strategies.
1. Strategic Risk
If you’re like most small businesses, you probably have a business plan and strategy. So, what
happens when your operation deviates from your business model? This is known as a strategic
risk. Some examples of strategic risks include:

 Technology changes
 Competitive pressure
 Legal changes
 Shifts in customer demand

So, if your customers no longer have interest in one of your products that can become a strategic
risk for your small business. To manage these types of risks, you’ll want to prioritize risk
management in your operation. It’s important to identify these risks before they can impact your
company’s finances.

2. Compliance Risk
If you fail to comply with a new regulation from the government or your state, you’ll face
compliance risks. These risks often involve:

 Corruption
 Discrimination or harassment in your workplace
 Workplace health and safety violations
 Environmental regulations
 Data storage issues

So, if your small business is polluting a local river and is not operating in accordance with the
environmental regulations in your state, your business may have to pay a fine. Your business may
also need to pay a fine if it does not follow data protection rules. To avoid compliance risks, you’ll
need to establish expected behavior in your workforce and document it in a manual. You’ll then
need to communicate this with your employees.

3. Financial Risk
Financial risks, or economic risks, impact your profits and therefore, your company’s ability to
grow. For example, if your company debt is higher than your cash flow, your business is
considered at financial risk. It’s also important to be aware of your interest rates on loans and how
that will impact your cash flow. These interest rates are an important factor in looking at your
company’s overall credit risk.

You can implement strategies for financial risks, including:

 Carrying insurance to cover any unexpected accidents or disasters at your small business
 Setting aside an emergency fund
 Having an exit strategy for investments your business makes
 Keeping debt to a minimum
4. Operational Risk
Operational risks include events that cause your small business to have to stop running. Some
examples of this include:

 Natural disasters
 Theft
 Vandalism
 Failures in technology
 Changes in laws and regulations

While most of these events are unpredictable or out of your control, you can prepare by getting
coverage, like business interruption insurance or equipment breakdown coverage. This policy can
help pay your expenses if your business needs to temporarily shut down for covered losses. It can
help pay for the revenue you’d normally make if your business was open. It also helps pay for
your:

 Rent
 Loan payments
 Taxes
 Payroll

5. Reputational Risk
Reputational risks involve the harm of your business’ public image. This can come from a negative
news story creating bad publicity or customers having poor experiences with your small business.
Either way, brand loyalty is often damaged, which ultimately reduces your profits and your
customer base. Some examples of events that can pose reputational risks for your business
include:

 Data breaches
 Defective products
 Negative social media posts
 Workplace accidents

You can protect your reputation by addressing customers that write negative reviews and helping
find a solution. This can be a refund or sending them a gift card. You can also encourage customers
to write positive reviews.

It’s also important to invest in cybersecurity and get the right insurance coverage for your
operation. Be sure to set time aside and look for potential risks in your operation. Regular
maintenance of your facility and equipment can also help prevent workplace injury.

6. Global Risk
If you do business in a foreign country, you’ll likely face global risks. For example, a natural
disaster that disrupts your business operation in another country can impact your income and
 supply chain in the U.S. Geopolitical issues in other countries can also cause temporary shutdowns
or sanctions that impact your operation.

It’s important to try and anticipate global risks and implement risk engineering strategies that can
help if an event puts your small business in jeopardy. It’s also important to note that global
businesses face more competition than companies that operate within the U.S. You’ll want to foster
innovation within your company to give you a competitive edge in your market.

7. Competitive Risk
Every business has competitors, but when other business’ actions are negatively impacting your
company, you face competitive risk. One of the biggest negative impacts that comes from your
competitors is losing your customers to them. This can occur for a variety of reasons. However,
there are ways to combat this. The most important thing to do is build up a loyal following. Some
strategies for doing this include:

 Communicating what your business stands for and your values

 Providing quality customer service
 Offering a loyalty program
 Asking for feedback
 Focusing on providing quality products or services

What Are the Types of Individual Risk?

The risk management process for individuals is complex given the variety of potential risks that
may be experienced over the life cycle and the differences that exist across households. In this
reading, key concepts related to risk management and individuals include the following:

 The two primary asset types for most individuals can be described broadly as human capital and
financial capital. Human capital is the net present value of the individual’s future expected labor
income, whereas financial capital consists of assets currently owned by the individual and can
include such items as a bank account, individual securities, pooled funds, a retirement account,
and a home.
 The total economic wealth of an individual changes throughout his or her lifetime, as do the
underlying assets that make up that wealth. The total economic wealth of younger individuals is
typically dominated by the value of their human capital. As individuals age, earnings will
accumulate, increasing financial capital.
 Earnings risk refers to the risks associated with the earnings potential of an individual—that is,
events that could negatively affect someone’s human and financial capital.
 Premature death risk relates to the death of an individual, such as a family member, whose future
earnings (human capital) were expected to help pay for the financial needs and aspirations of the
family.
 Longevity risk is the risk of reaching an age at which one’s income and financial assets are
insufficient to provide adequate support.
 Property risk relates to the possibility that one’s property may be damaged, destroyed, stolen, or
lost. There are different types of property insurance, depending on the asset, such as automobile
insurance and homeowner’s insurance.
 Liability risk refers to the possibility that an individual or other entity may be held legally liable
for the financial costs of property damage or physical injury.
 Health risk refers to the risks and implications associated with illness or injury. Health risks
manifest themselves in different ways over the life cycle and can have significant implications for
human capital.
 An individual’s total economic wealth affects portfolio construction through asset allocation,
which includes the overall allocation to risky assets, as well as the underlying asset classes, such
as stocks and bonds, selected by the individual.
 Investment risk, property risk, and human capital risk can be either idiosyncratic or systematic.
Examples of idiosyncratic risks include the risks of a specific occupation, the risk of living a very
long life or experiencing a long-term illness, and the risk of premature death or loss of property.
Systematic risks affect all households.

Risk management process

Steps of the risk management process
1. Identify the risk
2. Analyze the risk
3. Prioritize the risk
4. Treat the risk
5. Monitor the risk

With any new project comes new risks lying in wait. These risks can differ from misalignment
between stakeholders to lack of resources to major regulatory changes in the industry. Risks can
cause small delays or significant impacts, so it's important to understand your risks and how to
manage them for your best chance of success. This is especially important, considering a
staggering 65% of projects fail.

While your organization can’t entirely avoid risk, you can anticipate and mitigate risks through an
established risk management procedure. Follow this risk management framework to beat the odds
and streamline your team for success, making the team more agile and responsive when risks do
arise.

What is the risk management process?

It's simply that: an ongoing process of identifying, treating, and then managing risks. Taking the
time to set up and implement a risk management process is like setting up a fire alarm––you hope
it never goes off, but you’re willing to deal with the minor inconvenience upfront in exchange for
protection down the road.

Identifying and tracking risks that might arise in a project offers significant benefits, including:
 More efficient resource planning by making previously unforeseen costs visible
 Better tracking of project costs and more accurate estimates of return on investment
 Increased awareness of legal requirements
 Better prevention of physical injuries and illnesses
 Flexibility, rather than panic, when changes or challenges do arise
Risk management Process

Follow these risk management steps to improve your process of risk management.

1. Identify the risk

Anticipating possible pitfalls of a project doesn't have to feel like gloom and doom for your
organization–quite the opposite. Identifying risks is a positive experience that your whole team
can take part in and learn from. Project risks are anything that might impact the project’s schedule,
budget, or success.

Leverage the collective knowledge and experience of your entire team. Ask everyone to identify
risks they've either experienced before or may have additional insight about. This process fosters
communication and encourages cross-functional learning.

2. Analyze the risk

Once your team identifies possible problems, it's time to dig a little deeper. How likely are these
risks to occur? And if they do occur, what will the ramifications be? How will you respond?

During this step, your team will estimate the probability and fallout of each risk to decide where
to focus first. Then you will determine a response plan for each risk. Factors such as potential
financial loss to the organization, time lost, and severity of impact all play a part in accurately
analyzing each risk. By putting each risk under the microscope, you’ll also uncover any common
issues across a project and further refine the risk management process for future projects.

3. Prioritize the risk

Now prioritization begins. Rank each risk by factoring in both its likelihood of happening and its
potential effect on the project.

This step gives you a holistic view of the project at hand and pinpoints where the team's focus
should lie. Most importantly, it’ll help you identify workable solutions for each risk. This way, the
risk management workflow itself is not interrupted or delayed in significant ways during the
treatment stage.

4. Treat the risk

Once the worst risks come to light, dispatch your treatment plan. While you can’t anticipate every
risk, the previous steps of your risk management process should have you set up for success.
Starting with the highest priority risk first, task your team with either solving or at least mitigating
the risk so that it’s no longer a threat to the project.

Effectively treating and mitigating the risk also means using your team's resources efficiently
without derailing the project in the meantime. As time goes on and you build a larger database of
past projects and their risk logs, you can anticipate possible risks for a more proactive rather than
reactive approach for more effective treatment.

5. Monitor the risk

Clear communication among your team and stakeholders is essential when it comes to ongoing
monitoring of potential threats. Send regular project updates to the team and other stakeholders.
Check in with your risk managers individually to ensure there aren’t any red flags popping up
throughout the project.

Be sure to actively maintain the risk register—it should be a living document that you and your
team refer to often. As risks change or evolve, those should be updated in the log for everyone to
see. That way, everyone can stay on the same page and respond to risks faster and more
proactively.

Methods for Risk Management

There are five basic techniques of risk management:
1. Avoidance
2. Retention
3. Spreading
4. Loss Prevention and Reduction
5. Transfer (through Insurance and Contracts)

1. Avoidance: Many times it is not possible to completely avoid risk but the possibility should
not be overlooked. For example, at the height of a thunderstorm, Physical Plant may not
release vehicles for travel until the weather begins to clear, thus avoiding the risk of auto
accidents during severe weather. Some buildings on campus have had repeated water
problems in some areas. By not allowing storage of records or supplies in those areas, some
water damage claims may be avoided.
2. Retention: At times, based on the likely frequency and severity of the risks presented,
retaining the risk or a portion of the risk may be cost-effective even though other methods of
handling the risk are available. For example, the University retains the risk of loss to fences,
signs, gates and light poles because of the difficulty of enumerating and evaluating all of these
types of structures. When losses occur, the cost of repairs is absorbed by the campus
maintenance budget, except for those situations involving the negligence of a third party.
Although insurance is available, the University retains the risk of loss to most University
personal property.
3. Spreading: It is possible to spread the risk of loss to property and persons. Duplication of
records and documents and then storing the duplicate copies in a different location is an
example of spreading risk. A small fire in a single room can destroy the entire records of a
department's operations. Placing people in a large number of buildings instead of a single
facility will help spread the risk of potential loss of life or injury.
4. Loss Prevention and Reduction: When risk cannot be avoided, the effect of loss can often
be minimized in terms of frequency and severity. For example, Risk Management encourages
the use of security devices on certain audio visual equipment to reduce the risk of theft. The
University requires the purchase of health insurance by students who are studying abroad, so
that they might avoid the risk of financial difficulty, should they incur medical expenses in
another country.
5. Transfer: In some cases risk can be transferred to others, usually by contract. When outside
organizations use University facilities for public events, they must provide evidence of
insurance and name the University as an additional insured under their policy, thereby
transferring the risk of the event from the University to the facility user. The purchase of
insurance is also referred to as a risk transfer since the policy actually shifts the financial risk
of loss, contractually, from the insured entity to the insurance company. Insurance should be
the last option and used only after all other techniques have been evaluated.
6. Contracts: Often vendors and service providers will attempt through a contract to release
themselves from all liability for their actions relating to the contract. These are often referred
to as "hold harmless or indemnification" clauses.
Types of Risk: Assessment and Measurement
What is Risk in Finance?
Before proceeding to understand the different types of risk, let us first understand the meaning
of risk in finance. Risk refers to the probability of an actual result differing from the expected
results. While studying the CAPM, the risk is indicated as the volatility of returns. If a payoff
or cash flow is farther away in the future, the uncertainty increases, thus the risk as well. Do
understand that there is a strong and positive correlation between time and uncertainty.
Components of Risk Mitigation:

 Risk Identification: Recognizing and documenting potential risks that could negatively impact
the project or organization.
 Risk Assessment: Evaluating the potential impact of the identified risks. This often involves
quantitative and qualitative methods.
 Risk Prioritization: Ranking risks based on their potential impact and likelihood to help focus
on the most significant threats.
 Risk Response Planning: Developing strategies to address each risk. Common strategies
include:
 Avoidance: Taking actions to eliminate the risk.
  Mitigation: Bringing down the likelihood or impact of the risk.
 Transfer: Shifting the risk to another party, often through insurance or contracts.
 Acceptance: Acknowledging the risk and preparing to deal with its consequences.
 Implementation: Putting the risk response plans into action.
 Monitoring and Review: Continuously monitoring the environment for new risks and
reviewing the effectiveness of the risk response strategies.
 Communication: Keeping all stakeholders informed about the risks and the measures taken
to address them.
 Contingency Planning: Preparing backup plans in case the primary risk response strategies fail.
 Risk Documentation: Maintaining a risk register or database to document all identified risks,
their assessments, response plans, and status.
 Training and Education: Ensuring that team members and stakeholders are aware of the risks
and understand their roles in the risk mitigation process.
How do professionals assess risk?
Let us understand the following ways in which professionals assess any risk:

 Risk assessment: It is a process that identifies potential hazards and assesses what may
happen in case a hazard occurs. Using business impact analysis (BIA), the potential impacts are
determined that may occur due to the interruption of critical business processes.
 Risk analysis: It is the process of identifying and analyzing any potential future events that can
adversely impact any company. The company performs risk analysis for understanding what
might occur as well as the financial implications of an event. In this process, the steps taken to
mitigate and eliminate the risk are also assessed.
 Risk evaluation: It is the process to identify and measure risk related to
projects, operations and investments. In this step, the probability and impact of every
identified risk are identified. This can be done by rough estimation in terms of low, medium
and high.
 Risk management: This process involves identifying, assessing and controlling financial and
legal risks to the earnings of an organization. These threats root in several reasons, such as
strategic management errors and legal liabilities. In case an unforeseen event occurs without
any backup, its impact can be minor to serious.
Types of Risk
The following are different types of risks in finance:

1. Financial Risk
For most businesses, one of the biggest concerns is financial risk. It refers to the losing money
due to a business or an investment decision. Risks associated with finances may lead to loss of
capital for both businesses and individuals. When a financial risk occurs, there is a possibility that
the cash flow of the company may be insignificant to fulfil its obligations. Different types of
financial risk include credit risk, operation risk, liquidity risk, foreign investment, and legal and
equity risk.

2. Systematic risk
Systematic risk is also known as volatility risk, market risk or un-diversifiable risk. It is a risk that
is inherent to either the entire market or to a market segment. This type of risk is both
unpredictable and inevitable. However, the impact of systematic risk can be mitigated through
hedging to a certain extent. Systematic risk involves inflation, recession, interest rate changes
and other changes.
3. Unsystematic risk
This type of specific risk is unique to a particular company. It is a non-systematic risk that can be
reduced via diversification. The main difference between systematic and unsystematic risk is that
systematic risk is inherent in the market. Strikes, natural disasters and legal proceedings are some
examples of unsystematic risks. Here is the unsystematic risk formula:

Unlike systematic risk, which affects the entire market, unsystematic risk is unique to a particular
company or industry.

There is no standardized formula to calculate unsystematic risk directly, but it can be derived
using the total risk formula:

Total Risk = Systematic Risk + Unsystematic Risk

This formula can be rearranged for solving unsystematic risk:

Unsystematic Risk=Total Risk−Systematic Risk

Here:

Total Risk is the overall risk associated with an investment, often measured by the standard
deviation of the returns.

By understanding the total risk and the systematic risk, you can derive the unsystematic risk,
which represents the risk factors specific to the individual company or industry.

4. Market risk
Market risk refers to the possibility that an individual or an entity will experience losses. This may
occur due to several factors that can impact the overall performance of investments in financial
markets. It is synonymous with systematic risk and thus cannot be eliminated via diversification.
Recession, political upheavals, interest rate change or any natural calamity can cause market risk.
Such type of risk is capable of impacting the entire market at the same time.

5. Business Risk
This represents the exposure to an organization due to the factors that will lower its profits.
Anything that disrupts the ability of a company to achieve its financial goals is known as a business
risk. All these factors hamper the company’s ability to achieve financial goals and collectively
cause business risk.

6. Foreign Exchange Risk

It is the loss borne in an international financial transaction that may incur due to currency
fluctuations. Foreign exchange element of risk is also known as currency risk. It describes the
possibility that an investment value may decrease due to changes in relative value of involved
currencies.

7. Credit Risk
Credit refers to trust that allows one party to offer money and resource to other party. The
second party does not immediately reimburse the first party. However, the promise to repay or
return these resources in future is made. Credit risk arises when follower fails to repay on time
and does not meet their obligations.

Risk Measurement Metrics

The following risk metrics can be used for measuring risk:

1. Expected Value of Loss

One of the ways to measure risk involves calculating the expected value of the loss. Here, the
probabilities and consequences are combined into a single value. Here:

R = (probability of an accident occurring) x (expected loss in the case of an accident)

Suppose the probability of suffering from an accident is 0.01. Here, the loss is $1000. In this case,
the total risk is a loss of $10. The product of 0.01 and $1000.

2. Probability Distributions
When all consequences are expressed in the same unit, in that case, the risk can be expressed as
a probability density function that describes the uncertainty about an outcome.

R = p(x)
It can also be expressed as the cumulative distribution function (CDF) or an S curve.

3. Outcome frequencies
The risk of discrete events such as accidents is measured as outcome frequencies or the expected
rate of specific loss events per unit of time. The outcomes may be either individual or group risk.
In the case of individual risk, the frequency of a given level of harm to an individual is measured.
In the societal or group risk, the relationship between the frequency and number of people
suffering from that harm is calculated.
4. Volatility
This refers to the degree of variation of trading price over time. It is usually measured by the
standard deviation of logarithmic returns. According to the modern portfolio theory, using
variance or standard deviation, the risk of asset prices is measured as:
R=σ
The volatility of an individual asset to overall market changes is measured by the beta coefficient.
This refers to the contribution of assets to the systematic risk that cannot be eliminated using
portfolio diversification. This is the covariance between an asset’s return and market return. It is
expressed as the fraction of market variance.

Risk Management Tools and Techniques – Non-Insurance Methods

Here is an overview of the best 15 risk management tools and techniques:
1. Probability and Impact Matrix
The Probability and Impact Matrix is a foundational tool used in risk management. It evaluates
and prioritizes risks based on their likelihood of occurrence and potential impact on project
objectives.
Features
1. Categorization of risks into a grid
2. Prioritization based on predefined criteria
3. Visual representation of risk severity
Pros
 Simplifies complex risk data
 Enhances decision-making
 Facilitates communication among stakeholders
Cons
 Requires subjective judgments
 May oversimplify complex risks
2. Risk Data Quality Assessment
Risk data quality assessment evaluates the reliability and credibility of risk data, ensuring that risk
management decisions are based on accurate and high-quality information.
Features
1. Assessment of data source reliability
2. Evaluation of data accuracy
3. Identification of data limitations
Pros
 Improves the quality of risk analysis
 Reduces uncertainty in decision-making
 Identifies gaps in risk data
Cons
 Can be time-consuming
 Requires expertise to assess data quality
3. Risk Identification
Risk identification is a very important starting point within the risk management process. It
appropriately identifies and documents potential hazards to a project or organization. The company
considers internal and external factors to identify potential risks and hazards. This enables
organizations to handle challenges better and reduce their impact.
Features
1. Use of checklists, interviews, and brainstorming
2. Documentation of identified risks
3. Continuous throughout the project lifecycle
Pros
 Foundation for all risk management activities
 Encourages proactive risk management
 Better stakeholder management
Cons
 It can be overwhelming if not prioritized
 Dependent on the experience of the participants
4. SWOT Analysis
SWOT Analysis is a strategic planning tool for identifying Strengths, Weaknesses, Opportunities,
and Threats related to business competition or project planning.
Features
1. Examination of internal and external factors
2. Strategic insights into business or project
3. Facilitation of strategic planning
Pros
 Simple and versatile
 Promotes strategic thinking
 Identifies opportunities and threats
Cons
 May not prioritize issues
 Lacks detailed risk management
5. Risk Register
A Risk Register is usually a document that contains all information about identified risks, including
their status and mitigation plans.
Features
1. Comprehensive list of risks
2. Risk descriptions, impacts, and mitigation strategies
3. Tracking of risk ownership and status
Pros
 Centralizes risk information
 Facilitates monitoring and control
 Enhances transparency and accountability
Cons
 Requires regular updating
 It may become unwieldy with large projects
6. Root Cause Analysis
Root Cause Analysis is a problem-solving method that aims to identify the main cause of risk or
issues rather than merely addressing their symptoms.
Features
1. Use of tools like the 5 Whys and Fishbone Diagram
2. Identification of the primary cause of risk
3. Implementation of long-term solutions
Pros
 Prevents recurrence of issues
 Encourages deep understanding of problems
 Focuses on corrective actions
Cons
 Time-consuming
 Requires experienced facilitators
7. Decision-making
Decision-making involves analyzing potential risks and choosing the best action to minimize their
effects. By implementing decision-making into risk management, organizations can effectively
mitigate risks and deal with uncertainties.
Features
1. Analysis of alternatives
2. Use of decision matrices or decision trees
3. Stakeholder involvement in the decision process
Pros
 Facilitates informed choices
 Aligns risk response with strategic objectives
 Enhances stakeholder buy-in
Cons
 Can be subjective
 Potentially time-consuming consensus-building
8. Risk Acceptance
Risk Acceptance is a risk management strategy in which the decision is made to tolerate a risk's
impact without taking active steps to mitigate it.
Features
1. Acknowledgment of risk without direct action
2. Reserved for low-impact risks
3. Inclusion in the risk register for monitoring
Pros
 Cost-effective for managing low-priority risks
 Reduces unnecessary efforts on minor issues
 Simplifies risk management process
Cons
 Requires careful consideration to avoid complacency
 Potential for overlooked cumulative effects
9. Risk Reassessment
Risk Reassessment ensures that risk management strategies are relevant and practical by
conducting periodic reviews of the risk environment to identify new risks and reevaluate existing
ones.
Features
1. Regularly scheduled reviews
2. Adjustment of risk priorities
3. Adaptation of risk management plans
Pros
 Keeps risk management efforts aligned with changes
 Allows for proactive response to new risks
 Ensures continuous improvement in risk management
Cons
 Can be resource-intensive
 Requires ongoing commitment from all levels of management
10. Brainstorming
Brainstorming is a creative group problem-solving technique that generates a wide range of ideas
for risk identification and mitigation strategies.
Features
1. Facilitation of open and uninhibited discussion
2. Generation of a large number of ideas
3. Encouragement of innovative thinking
Pros
 Promotes team involvement and creativity
 Uncovers unique insights and solutions
 Enhances stakeholder engagement
Cons
 May produce a large volume of unfeasible ideas
 Requires effective facilitation to be productive
11. Risk Monitoring
Risk Monitoring is an essential process in risk management for identifying risks, monitoring
residual risks, and identifying emerging ones.
 Features
1. Regular tracking of risk triggers and impacts
2. Adjustment of risk responses based on monitoring data
3. Integration with overall project or organizational reporting
Pros
 Ensures that risks are actively managed throughout the project lifecycle
 Allows for timely adjustments to risk management strategies
 Improves overall risk awareness and preparedness
Cons
 Requires dedicated resources for monitoring activities
 It may be seen as burdensome without clear benefits
12. Delphi Technique
The Delphi Technique is a structured communication approach created as an interactive,
systematic forecasting process using a panel of experts.
Features
1. Anonymous feedback from experts
2. Iterative rounds of questioning
3. Consensus building among panel members
Pros
 Reduces the influence of dominant personalities
 Gathers diverse expert opinions
 Enhances accuracy of risk assessments
Cons
 Time-consuming process
 Depends on the selection of appropriate experts
13. Checklists
Checklists are simple yet effective tools to ensure the organization considers all potential project
risks and necessary risk management steps.
Features
1. Comprehensive lists of common risks and responses
2. Customizable to project or industry needs
3. Easy to use and understand
Pros
 Provides a systematic approach to risk identification
 Ensures no critical step is overlooked
 Facilitates quick reviews
Cons
 It may not cover all unique project risks
 This can lead to a false sense of security
14. Reserve Analysis
 Reserve Analysis involves setting aside contingency reserves (time, money, or resources) to
address risks that may have a higher probability of occurring and could cause a higher impact.
Features
1. Calculation of contingency reserves based on risk analysis
2. Integration into project budgets and schedules
3. Regular review and adjustment of reserves
Pros
 Provides a buffer for unforeseen risks
 Enhances flexibility and resilience of projects
 Supports more accurate budgeting and scheduling
Cons
 Ties up resources that could be used elsewhere
 Requires careful estimation to avoid over or under-reserving
15. Riskonnect
Riskonnect is a leading integrated risk management software solution that offers a comprehensive
suite of applications to help organizations identify, manage, and mitigate risks across their
operations.
Features
1. Integrated risk management across multiple domains
2. Real-time data analytics and reporting
3. Customizable dashboards and workflows
Pros
 Offers a holistic view of risk across the organization
 Streamlines risk management processes.
 Facilitates regulatory compliance and strategic decision-making
Cons
 It can be complex to implement
 It may require significant investment.
 UNIT II
Insurance as a Risk Management Techniques Principles
Principle of Indemnity - Definition, Functions, Importance
The principle of indemnity is a fundamental concept in insurance that governs the compensation
provided to the policyholder in the event of a loss. This principle is based on the idea that
insurance is designed to restore the insured to the financial position they were in before the loss
occurred, and it aims to prevent the policyholder from gaining a financial advantage through the
insurance contract.
Indemnity Meaning
Indemnity refers to a legal or financial obligation to compensate another party for any loss,
damage, or liability incurred. It is a form of protection or reimbursement against financial losses
or adverse consequences. The party providing indemnity, often referred to as the indemnitor,
agrees to make the other party, known as the indemnitee, whole by compensating them for
specific losses or damages.
Principle of Indemnity
The principle of indemnity is a fundamental concept in insurance that governs the compensation
provided to the policyholder in the event of a covered loss. This principle is based on the idea
that the purpose of insurance is to indemnify, or compensate, the insured party for the actual
financial loss suffered due to an insured event. The key elements of the principle of indemnity
include:
o Financial Restoration: The primary objective of indemnity is to restore the insured to the
financial position they were in before the covered loss occurred. The insurance payout is
intended to cover the actual economic loss suffered, preventing the insured from making
a profit from the insurance contract.
o No Overcompensation: The principle prohibits the insured from receiving more than the
actual amount of the loss. The insurance company is not obligated to provide
compensation exceeding the financial loss suffered by the insured.
o Insurable Interest Requirement: To claim indemnity, the insured must have an insurable
interest in the subject matter of the insurance. This ensures that the insured has a
legitimate financial interest in the property or person being insured.
 o Practical Application in Property Insurance: The principle of indemnity is often evident
in property insurance. In the case of property damage or loss, the insurer compensates
the policyholder for the cost of repair, replacement, or the actual cash value of the
property at the time of the loss.
o Depreciation Considerations: When calculating indemnity for property insurance,
depreciation may be taken into account. This reflects the reduction in the value of
property over time, ensuring that the compensation aligns with the actual value at the
time of the loss.
o Prevention of Moral Hazard: The principle of indemnity helps prevent moral hazard by
discouraging the insured from intentionally causing a loss to gain financially. The insured
should have a genuine interest in protecting the insured property or person.
o Application in Different Types of Insurance: The principle of indemnity is applicable
across various types of insurance, including property insurance, liability insurance, and
health insurance. In each case, the goal is to provide compensation for actual losses
without allowing for financial gain.
Features of the Principle of Indemnity
The features have been stated below.
o Financial Restoration: The primary objective is to restore the insured to the financial
position they were in before the covered loss occurred.
o No Financial Gain: The insured should not profit from the insurance contract. The
compensation is limited to the actual loss suffered.
o Insurable Interest: The insured must have a valid insurable interest in the subject matter
of the insurance for the principle to apply.
o Compensation Limits: The compensation is limited to the amount of the actual loss or the
policy limits, whichever is lower.
o Depreciation Consideration: Depreciation may be taken into account, especially in
property insurance, to reflect the actual value of the property at the time of the loss.
Exceptions to the Principle of Indemnity
The exceptions have been stated below.
o Life Insurance: Life insurance is not strictly based on the principle of indemnity. The
insurer pays a predetermined sum (the face amount) upon the death of the insured,
regardless of the actual financial loss suffered.
o Personal Accident Insurance: Similar to life insurance, personal accident insurance may
pay a predetermined sum for specific injuries or events, deviating from the strict
application of the principle of indemnity.
o Valued Policies: Some policies, such as valued policies, specify a predetermined amount
of compensation irrespective of the actual loss. These are exceptions to the principle of
indemnity.
 o New-for-Old Policies: In certain policies, especially in marine insurance, "new-for-old"
clauses may allow for the replacement of damaged or lost items with new ones, without
considering depreciation.

Principle of Indemnity Example

Let's consider a property insurance example:
o Scenario: A policyholder insures a building for its market value of $500,000. A covered
event causes damage to the building.
o Principle of Indemnity Application: The insurer, applying the principle of indemnity,
assesses the actual loss. If the cost of repair is $50,000, the insured is indemnified for that
amount. If the actual cash value of the damaged property is less due to depreciation, the
indemnity may be adjusted accordingly.
Application of the Principle of Indemnity
The application has been stated below.
o Property Insurance: In cases of property damage or loss, the principle of indemnity is
applied to compensate the insured for the actual financial loss suffered, considering
factors like repair costs and depreciation.
o Liability Insurance: While liability insurance is not based on the principle of indemnity, it
still involves compensating the insured for actual financial losses resulting from covered
liability claims.
o Health Insurance: In health insurance, the principle of indemnity is applied when
reimbursing the insured for actual medical expenses incurred, up to the policy limits.
o Motor Insurance: Following an accident, motor insurance applies the principle of
indemnity by compensating the insured for the repair costs or the actual cash value of the
damaged vehicle.

Principle of insurable interest

The principle of insurable interest is a fundamental insurance industry principle that states
that a person or entity must have a financial or legal stake in the insured subject in order to
purchase insurance on it:

 Explanation
Insurable interest means that the policyholder would suffer a financial loss if the insured
subject were to be damaged, destroyed, stolen, or lost. This principle is important because
it ensures that insurance policies are used to protect against genuine financial losses, rather
than for speculation or gambling.
 Examples
 Life insurance: The policyholder must have a legitimate financial interest in the life of the
insured, such as standing to suffer a financial or emotional loss if the insured dies.
 Property insurance: The policyholder must own, lease, or have a financial stake in the
property. For example, a property owner, contractor, or financier can have an insurable
interest in a property.
 Insurance contract
Without insurable interest, an insurance contract is not legally enforceable by either the
insurer or the policyholder. An insurance contract without insurable interest is essentially
the same as a wagering agreement and is therefore void.

Principle of Subrogation
What Is Subrogation?
Subrogation is a term describing the right held by most insurance carriers to legally pursue a
third party that caused an insurance loss to an insured. This allows the insurance carrier to
recover the amount of the claim it paid to the insured for the loss.
Understanding Subrogation
Subrogation refers to the act of one person or party standing in the place of another person or
party. It effectively defines the rights of the insurance company both before and after it has paid
claims made against a policy. Also, it makes the process of obtaining a settlement under an
insurance policy easier.
When an insurance company pursues a third party for damages, it is said to "step into the shoes
of the policyholder." Thus, the carrier will have the same rights and legal standing as the
policyholder when seeking compensation for losses. If the insured party does not have the legal
standing to sue the third party, the insurer will also be unable to pursue a lawsuit as a result.
How Subrogation Works
In most cases, an individual’s insurance company pays its client’s claim for losses directly, then
seeks reimbursement from the other party or their insurance company. In such cases, the
insured typically receives prompt payment. Then the insurance company may pursue a
subrogation claim against the party at fault for the loss.
Insurance policies may contain language that entitles an insurer, once losses are paid on claims,
to seek recovery of funds from a third party if that third party caused the loss. The insured does
not have the right to file a claim with the insurer to receive the coverage outlined in the
insurance policy or to seek damages from the third party that caused the losses.
Subrogation enables accident victims to receive claim payments more quickly after a loss.
Subrogation (sometimes shortened to "subro") in the insurance sector, especially among auto
insurance policies, occurs when the insurance carrier takes on the financial burden of the
insured as the result of an injury or accident payment and seeks repayment from the at-fault
party. The subrogation process can take weeks, months, or even years to complete, depending
on the complexity of the case, state regulations, and other factors.
Example of Subrogation
One example of subrogation is when an insured driver's car is totaled through the fault of
another driver. The insurance carrier reimburses the covered driver under the terms of the
policy and then pursues legal action against the driver at fault. If the carrier is successful, it must
divide the amount recovered after expenses proportionately with the insured to repay
any deductible paid by the insured.
Subrogation is not only relegated to auto insurers and their policyholders. Subrogation also
occurs within the health care sector. If, for example, a health insurance policyholder is injured
in an accident and the insurer pays $20,000 to cover the medical bills, that same health
insurance company is allowed to collect $20,000 from the at-fault party to reconcile the
payment.
Subrogation Process for the Insured
Luckily for policyholders, the subrogation process is extremely passive for the victim of an
accident when another party is at fault. The subrogation process is meant to protect insured
parties; the insurance companies of the two parties involved work largely behind the scense to
mediate and come to agreement over the payment.3
Policyholders are simply covered by their insurance company and can act accordingly. The
insured party benefits because the at-fault party must make a payment during subrogation to
the insurer, which helps keep the policyholder's insurance rates low.
Insurance companies do most of the work during subrogation, freeing the insured from having
to participate in the process.
In the case of any accident, it remains important to stay in communication with the insurance
company. Make sure all accidents are reported to the insurer in a timely manner and let the
insurer know if there should be any settlement or legal action. If a settlement occurs outside of
the normal subrogation process between the two parties in a court of law, it is often legally
impossible for the insurer to pursue subrogation against the at-fault party. This is due to the fact
most settlements include a waiver of subrogation.
Benefits of Subrogation
In insurance, subrogation allows your insurer to recover the costs associated with a claim, such
as medical bills, repairs costs, and your deductible, from the at-fault party's insurer (assuming
you were not at-fault). This means that both you and your insurer can recoup the costs of
damage or harm caused by somebody else.
It also means improved loss ratios, profits, and underwriting revenue for the insurer, plus added
customer satisfaction and protection.
Waivers of Subrogation
A waiver of subrogation is a contractual provision where an insured waives the right of their
insurance carrier to seek redress or compensation for losses from a negligent third
party. Typically, insurers charge an additional fee for this special policy endorsement. Many
construction contracts and leases include a waiver of subrogation clause.
Such provisions prevent one party’s insurance carrier from pursuing a claim against the other
contractual party in an attempt to recover money paid by the insurance company to the insured
or to a third party to resolve a covered claim. In other words, if subrogation is waived, the
insurance company cannot "step into the client's shoes" once a claim has been settled and sue
the other party to recoup their losses. Thus, if subrogation is waived, the insurer is exposed to
greater risk.
Principle of Utmost Good Faith
Principle of Uberrimae Fidei, a Latin Phrase meaning Principle of Utmost Good Faith is one of the
fundamental principles of Insurance which states that both parties to an Insurance Contract, that
is, the Insured and Insurance Company, should act in Good Faith towards one another.
Thus, it is the Insured’s duty to inform the Insurance Company of all Material Facts so that the
company is fully aware of the risks and can offer a suitable cover by charging appropriate
premium.
What is Principle of Utomost Good Faith is also Knows as?
Principle of Utmost Good Faith is known as ubberimae fidei in Latin, means that both, the Insured
and the Insurance Company, have to act in Good Faith, Honesty and Fair Dealing towards each
other.
Principle of Utmost Good Faith is a fundamental principle in Insurance and requires that, both
the Insured and Insurance Company are transparent and disclose all material information before
entering into an Insurance Contract.
What happens if the Principle of Utmost Good Faith is breached by the Insured?
If the Principle of Utmost Good Faith is breached, the Insurance Company can reject the proposal.
The Principle of Utmost Good Faith can be breached in 2 ways:
Non-Disclosure of Material Facts
Not disclosing Material Facts means that the Insurance Company cannot make an informed
decision whether to accept the risk or not. This means that the risk accepted by the Insurance
Company is different from what it would have been had all the material facts been disclosed. If
the Insurance Company comes to know about the withheld information, it can cancel
the Insurance Policy.
Example of Non-Disclosure of Material Facts
Mr Ramesh had purchased a Term Life Insurance Policy. However, he did not disclose his smoking
and drinking habit while purchasing the Policy. Mr Ramesh withheld material information which,
if disclosed, would have resulted in a higher premium.
Upon finding out, the Insurance Company cancelled the policy.
Misrepresentation of Material Facts
Misrepresentation means Giving Wrong Information which also breaches the Principle of Utmost
Good Faith. This may also lead to Policy Cancellation.
Example of Misrepresentation of Material Facts
Mr Ajay had purchased a Fire Insurance Policy where he gave wrong information about the risk
occupancy in order to obtain a lower premium. Upon finding out, the Insurance Company
cancelled the policy.
Duty of Utmost Good Faith for the Insurance Company
Just as the Insured has a duty of disclosing all material facts to the Insurance Company, the
Insurance Company also has a duty of Utmost Good Faith to the Insured.
The Insurance Company has superior knowledge about the terms and conditions of the Insurance
Policy. It is the duty of the Insurance Company to inform the Insured of the same and a failure to
do so constitutes Breach of Duty of Utmost Good Faith by the Insurance Company.
Thus, Insurance Company must provide the Insured with a prospectus of the Insurance Policy
before purchase, which explains the coverages, terms and conditions of the Policy.
With regards to an Insurance Claim, the Insurance Company is duty bound to approach the
investigation and settlement of the claim in a fair and just manner. If the Insurance Company
does not act fairly in claim settlement, it also constitutes a breach of duty of good faith.
When is the Duty of Utmost Good Faith required in Insurance?
The Duty of Utmost Good Faith is required at all stages of an Insurance Policy. It is the duty of the
Insured to keep the Insurance Company appraised of any change in the risk profile of the subject
matter.
Consider an example where Mr ABC has purchased a Factory and Warehouse Insurance Policy.
He stores non-hazardous stocks in the warehouse. Now, Mr ABC starts manufacturing a new
product which requires a hazardous raw material. If this hazardous raw material is stored in the
warehouse, the same should be promptly communicated to the Insurance Company and
additional premium for the change in risk occupancy should be paid.
At every renewal, the Insured should intimate the Insurance Company of any change in risk
profile and value of the subject matter to be insured.
Requisites of Insurable Risks
Insurance companies won't insure against every possible risk. Most providers only cover pure
risks, as opposed to speculative risks. Pure risks embody most or all of the main elements of
insurable risk. These elements are "due to chance," definiteness and measurability, statistical
predictability, lack of catastrophic exposure, random selection, and large loss exposure.
Understanding the elements of insurable risk can help you determine which coverage is right
for your situation—and make appropriate plans to safeguard your property, protect your loved
ones, and secure your business.
Pure Risk vs. Speculative Risk
Insurance companies normally only indemnify against pure risks, otherwise known as event
risks. A pure risk includes any uncertain situation where the opportunity for loss is present and
the opportunity for financial gain is absent.
Speculative risks are those that might produce a profit or loss, namely business ventures or
gambling transactions. Speculative risks lack the core elements of insurability and are almost
never insured.
Examples of pure risks include natural events, such as fires or floods, or other accidents, such as
an automobile crash or an athlete seriously injuring his or her knee. Most pure risks can be
divided into three categories: personal risks that affect the income-earning power of the insured
person, property risks, and liability risks that cover losses resulting from social interactions.
Note
Not all pure risks are covered by all private insurers. For example, property damage due to
flooding is considered a pure risk but won't be covered under most homeowners’ policies.

Due to Chance
An insurable risk must have the prospect of accidental loss, meaning that the loss must be the
result of an unintended action and must be unexpected in its exact timing and impact.
The insurance industry normally refers to this as "due to chance." Insurers only pay out claims
for loss events brought about through accidental means, though this definition may vary from
state to state. It protects against intentional acts of loss, such as a landlord burning down his or
her own building.

Definiteness and Measurability

For a loss to be covered, the policyholder must be able to demonstrate a definite proof of loss,
normally in the form of bills in a measurable amount. If the extent of the loss cannot be
calculated or cannot be fully identified, then it is not insured. Without this information, an
insurance company can neither produce a reasonable benefit amount or premium cost.
For an insurance company, catastrophic risk is simply any severe loss deemed too expensive,
pervasive, or unpredictable for the insurance company to reasonably cover.

Statistically Predictable
Insurance is a game of statistics, and insurance providers must be able to estimate how often a
loss might occur and the severity of the loss. Life and health insurance providers, for example,
rely on actuarial science and mortality and morbidity tables to project losses across populations.

Not Catastrophic
Standard insurance does not guard against catastrophic perils. It might be surprising to see an
exclusion against catastrophes listed among the core elements of an insurable risk, but it makes
sense given the insurance industry's definition of catastrophic, often abbreviated as "cat."
There are two kinds of catastrophic risk. The first is present whenever all or many units within a
risk group, such as the policyholders in that class of insurance, are all be exposed to the same
event. Examples of this kind of catastrophic risk include nuclear fallout, hurricanes, or
earthquakes.
The second kind of catastrophic risk involves any unpredictably large loss of value not
anticipated by either the insurer or the policyholder. Perhaps the most infamous example of this
kind of catastrophic event occurred during the terrorist attacks on Sept. 11, 2001.
Some insurance companies specialize in catastrophic insurance, and many insurance companies
enter into reinsurance agreements to guard against catastrophic events. Investors can even
purchase risk-linked securities, called "cat bonds," which raise money for catastrophic risk
transfers.

Randomly Selected and Large Loss Exposure

All insurance schemes operate based on the law of large numbers. This law states there must
be a sufficient large number of homogeneous exposures to any specific event in order to make
a reasonable prediction about the loss related to an event.
A second related rule is that the number of exposure units, or policyholders, must also be large
enough to encompass a statistically random sample of the overall population. This is designed
to prevent insurance companies from only spreading risk among those most likely to generate
a claim, as might occur under adverse selection.

Requirements of an Insurance Contract

Contract law

In general, an insurance contract must meet four conditions in order to be legally valid: it must
be for a legal purpose; the parties must have a legal capacity to contract; there must be evidence
of a meeting of minds between the insurer and the insured; and there must be a payment or
consideration.

To meet the requirement of legal purpose, the insurance contract must be supported by an
insurable interest (see further discussion below); it may not be issued in such a way as to
encourage illegal ventures (as with marine insurance placed on a ship used to carry contraband).

The requirement of capacity to contract usually means that the individual obtaining insurance
must be of a minimum age and must be legally competent; the contract will not hold if the
insured is found to be insane or intoxicated or if the insured is a corporation operating outside
the scope of its authority as defined in its charter, bylaws, or articles of incorporation.

The requirement of meeting of minds is met when a valid offer is made by one party and accepted
by another. The offer is generally made on a written application for insurance. In the field
of property and liability insurance, the agent generally has the right to accept the insured’s offer
for coverage and bind the contract immediately. In the field of life insurance, the agent generally
does not have this power, and the contract is not valid until the home office of the insurer has
examined the application and has returned it to the insured through the agent.
The payment or consideration is generally made up of two parts—the premiums and the promise
to adhere to all conditions stated in the contract. These may include, for example, a warranty that
the insured will take certain loss-prevention measures in the care and preservation of the
covered property.
Warranties
In applying for insurance, the applicant makes certain representations or warranties. If the
applicant makes a false representation, the insurer has the option of voiding the contract.
Concealment of vital information may be considered misrepresentation. In general, the
misrepresentation or concealment must concern a material fact—defined as a fact that would, if
it were known, cause the insurer to change the terms of the contract or be unwilling to issue it
in the first place. If the agent of the insurer asks the applicant a question the answer to which is
a matter of opinion and if the answer turns out to be wrong, the insurer must demonstrate bad
faith or fraudulent intent in order to void the contract. If, for example, in answer to an agent’s
question, the applicant reports no history of serious illness, in the mistaken belief that a past
illness was minor, the court may find the statement to be an honest opinion and not a
misrepresented fact.

A basic principle of property liability insurance contracts is the principle of subrogation, under
which the insurer may be entitled to recovery from liable third parties. In fire insurance, for
example, if a neighbor carelessly sets fire to the insured’s house and the insurance company
indemnifies the insured for the loss, the company may then bring a legal action in the name of
the insured to recover the loss from the negligent neighbor. The principle of subrogation is
complemented by another basic principle of insurance contract law, the principle of indemnity.
Under the principle of indemnity a person may recover no more than the actual cash loss; one
may not, for example, recover in full from two separate policies if the total amount exceeds the
true value of the property insured.

Insurable interest

Closely associated with the above legal principles is that of insurable interest. This requires that
the insured be exposed to a personal loss if the peril insured against should occur. Otherwise it
would be possible for a person to take out a fire insurance policy on the property of others and
collect if the property burned. Any financial interest in property, or reasonable expectation of
having a financial interest, is sufficient to establish insurable interest. A secured creditor such as
a mortgagee has an insurable interest in the property on which money has been lent.

In the field of personal insurance one is held to have an unlimited interest in one’s own life. A
corporation may take life insurance on the life of a key executive. A wife may insure the life of
her husband, and a father may insure the life of a minor child, because there is a sufficient
pecuniary relationship between them to establish an insurable interest.

In life insurance the insurable interest must exist at the time of the contract. Continued insurable
interest, however, need not be demonstrated. A divorced woman may continue life insurance on
the life of her former husband and legitimately collect the proceeds upon his death even though
she is no longer his wife.

In the field of property insurance, on the other hand, the insurable interest must be
demonstrated at the time of the loss. If an individual insures a home but later sells it, no recovery
can be made if the house burns after the sale, because the insured has suffered no loss at the
time of the fire.

Liability law

In most countries, an individual may be held legally liable to another for acts or omissions and be
required to pay damages. Liability insurance may be purchased to cover these contingencies.

Legal liability exists when an individual commits a legal injury that wrongly encroaches on another
person’s rights. Such injuries include slander, assault, and negligent acts. A negligent act involves
failure to behave in a manner expected when the results of this failure cause a financial loss to
others. An act may be classed as negligent even if it is unintentional. Negligence may be imputed
from one person to another. For example, a master is liable not only for his own acts but also for
the negligent acts of servants or others legally representing him. It is not uncommon for a
municipality to require that businesses using city property assume what would otherwise have
been the city’s negligence for the use of its property. Statutes may impute liability on individuals
when no liability would exist otherwise; thus a parent may be legally liable for the acts of a minor
child who is driving the family automobile.

In common-law countries such as the United States and the United Kingdom, three defenses may
be used in a negligence action. These are assumed risk, contributory negligence, and the fellow
servant doctrine. Under the assumed risk rule, the defendant may argue that the plaintiff has
assumed the risk of loss in entering into a given venture and understands the risks. Employers
formerly used the assumed risk doctrine in suits by injured employees, arguing that the employee
understood and assumed the risks of employment in accepting the job.

The contributory negligence defense is frequently used to defeat negligence actions. If it can be
shown that one party was partly to blame, then that party may not collect from any negligence
of the other party. Some courts have applied a substitute doctrine known as comparative
negligence. Under this, each party is held responsible for a portion of the loss corresponding to
the degree of blame attached to that party; a person who is judged to be 20 percent to blame
for an accident may be required to pay 20 percent of the injured person’s losses.

The fellow servant defense has been used at times by employers; an employer would argue in
some cases that the injury to an employee was caused not by the employer’s negligence but by
the negligence of another employee. However, workers’ compensation statutes in some
countries have nullified such common law defenses in industrial injury cases.

In many countries, the courts have tended to apply increasingly strict standards in adjudicating
negligence. This has been termed the trend toward strict liability, under which the plaintiff may
recover for almost any accidental injury, even if it can be shown that the defendant has used
“due care” and thus is not negligent in the traditional sense. In the United States, manufacturers
of polio vaccine that was found to have caused polio were required to pay large damage claims
although it was demonstrated that they had taken all normal precautions and safeguards in the
manufacture of the vaccine.

Insurance Contract: Features, Term & Conditions of

Insurance Contract (How it Works)
Insurance Contract is an agreement between Insured and Insurer enforceable by law. Here
Insurer promises to pay sum assured on occurrence of an event like death. In exchange insured
promises to pay regular premium.

Insurance Contract Terms and Conditions

A valid legal contract must follow certain conditions which is binding on all parties. These
conditions are listed below:
1. Offer and Acceptance
Here to be insured proposes with definite terms and conditions and Insurer can revert with three
options:
 Accept the proposal under standard T & C
 Reject the proposal by giving specific answer
 Revise by giving a counter offer.

2. Consideration
To enforce the contract. Proposer must pay a premium which is called consideration. This
premium is given in exchange of promise by Insurer to pay claim. So a contract is valid only if the
Insurer accepts the application form along with premium and insurer accepts the proposal and
confirms the same in writing.
3. Legal Purpose
A contract is valid only if the purpose of contract is legal. Insurance purpose is considered legal
as insurer is managing the risk and insurer is creating a pool for risk management
4. Competent Parties
A legal contract must be made with competent person which means contract cannot be made
with minors, mentally infirm and people under use of drug. Insurer in India must have a license
from IRDA.

Features of Insurance Contract

Given below are the few features of Insurance contract, these features are unique:-
1. Aleatory
Insurance contracts are Aleatory as promise comes into picture only on occurrence of event. This
occurrence of event is based on probability and occurrence of event is not controlled by any
party.
2. Adhesion
Here contract is prepared by insurer and insured accepts given terms and conditions without any
negotiation.
3. Unilateral
Here Insurer makes any enforceable promise. Insured does not make any promise but bound by
the terms and conditions of policy where contract can be lapsed if renewal premiums are not
paid.
4. Personal Contract
Life insurance is a personal contract or personal agreement between the insurer and the insured.
The owner of the policy has no bearing on the risk the insurer has assumed. For this reason,
people who buy life insurance policies are called policy owners rather than policyholders. Policy
owners actually own their policies and can give them away if they wish. This transfer of ownership
is known as assignment. To assign a policy, a policy owner simply notifies the insurer in writing.
The company will then accept the validity of the transfer without question. The new owner is
granted all of the rights of policy ownership.
5. Conditional
An insurance contract is conditional. This means that the insurer’s promise to pay benefits
depends on the occurrence of an event covered by the contract. If the event does not materialize,
no benefits are paid. Furthermore, the insurer’s obligations under the contract are conditioned
on the performance of certain acts by the insured or the beneficiary. For example, the timely
payment of premiums is a condition for keeping the contract in force. If premiums are not paid,
the company is relieved of its obligation to pay a death benefit.
6. Valued or Indemnity Contract:
An insurance contract is either a valued contract or an indemnity contract. A valued contract
pays a stated sum regardless of the actual loss incurred. Life insurance contracts are valued
contracts. If an individual acquires a life insurance policy insuring her life for Rs 500,000, that is
the amount payable at death. There is no attempt to value actual financial loss upon a person’s
death.
An indemnity contract, however, is one that pays an amount equal to the loss. Contracts of
indemnity attempt to return the insured to their original financial position. Fire and health
insurance policies are examples of indemnity contracts. An insured that owns a Rs. 500000 fire
insurance policy and suffers a Rs. 50,000 loss due to fire will be able to collect up to Rs. 50,000,
not Rs. 500,000.
7. Utmost Good Faith:
Insurance is a contract of utmost good faith. This means both the policy owner and the insurer
must know all material facts and relevant information. There can be no attempt by either party
to conceal, disguise, or deceive. A consumer purchases a policy based largely on the insurer and
agent’s explanation of the policy’s features, benefits, and advantages. Insurance applicants are
required to make a full, fair and honest disclosure of the risk to the agent and insurer.
8. Material Facts:
All facts which need can affect the occurrence of risk must be declared. It becomes part of the
contract and, if found to be untrue, can be grounds for revoking the contract. Facts are presumed
to be material because they affect the insurer’s decision to accept or reject an applicant.
In most cases, life insurers have only a limited period of time to uncover false warranties,
misrepresentations, or concealment. After that time period passes (normally two years from
policy issue), the contract cannot be voided or revoked for these reasons under section 45 of
Insurance Act
9. Insurable Interest:
Another element of a valid insurance contract is insurable interest. Insurable interest is a
component of legal purpose. Insurable interest is not defined but can be interpreted by the loss
to the proposer. Examples of Insurable Interest: Parents on children but children have no
interest on parents, Spouse on each other but husband cannot have an insurance on wife unless
husband is adequately insured, Employer on employee, Creditors on debtors. Insurable interest
should be there at initiation of contact and not at the time of occurrence of event.
Lastly Insurance Contract need to be seen from the perspective of Moral Hazard and underwriters
need to evaluate each case with an objective of Moral Hazard.
 Insurance Agent vs. Broker: What’s the Difference?
One thing that everyone who works in insurance can agree on is that clients should be seeking
guidance from professionals to make sure that they are getting the coverage they need and at
the right price.
However, the type of insurance professionals you are consulting could make a difference in the
results you get. Insurance agent vs. broker: Which should you consult when buying coverage for
yourself or your business?
Ask anyone outside of the insurance industry this question, and they will probably respond with
a question of their own: What’s the difference?
It’s safe to assume that most people do not know the difference between an insurance agent and
a broker and often use the two terms interchangeably.
The truth is that there are significant differences between what insurance agents and brokers do.
Understanding these differences will allow you to make an educated and, therefore, better
decision when it comes to purchasing coverage.
What Does an Insurance Agent Do?
Let’s start with the basics. An agent is a person who acts on behalf of a person or group. In the
insurance industry, an agent represents one or more insurers. The agent is responsible for
distributing the insurer’s products; their insurance policies. They can represent one or several
different insurance companies.
Agents act as intermediaries, providing potential buyers with information from the insurance
company or companies they represent. They have contracts with insurers that specify what
policies they are allowed to sell and how much money they can expect to make from selling these
policies. They also have the ability to bind the insurers into the policy contracts, which is usually
done directly inside the insurer’s underwriting systems. The fact that they can bind the insurer
because they represent the company is one of the key aspects in terms of what makes an agent
an agent.
There are two types of insurance agents:

Captive Agents
Captive agents work for one insurance company either full-time or as independent contractors.
They may receive operational support such as an office or administrative staff from the insurance
company that hires them. They often get referrals and leads on potential clients from the insurer
as well.
Captive agents are very knowledgeable about the insurance products that are being offered by
the insurer that they represent because those are the only products that they sell. Therefore,
they are able to provide clients with very detailed and up-to-date information about the coverage
they are selling but could be less aware of other products in the broader marketplace.

Independent Agents
Independent agents work with several insurers, and since they are not tied down to just one
company, they can often offer a wider range of insurance products. This means that they can
offer a wider distribution network for insurance companies than captive agents.
Independent agents will have the authority to quote and issue insurance policies on behalf of the
insurer(s) they represent, principally, through those insurer systems. The systems are designed
to offer certain policy types, pricing models, and support tools for customers. Those agents may
offer additional services to their customers, such as claims support, a review of other insurance
policies, and advice. They are very similar to insurance brokers; however, because their duty is
to the insurer and not the clients, they have limits to what they can offer a client.
What Does An Insurance Broker Do?
A broker is an insurance expert who legally represents people or businesses looking to buy
insurance. In some states, insurance brokers have a fiduciary duty to customers, meaning they
are required by law to act only in the best interest of their clients.
A broker will work with their clients to identify and put together the best possible insurance plan
for their specific coverage needs. They have no obligation to sell policies from one insurance
company or another, meaning they can shop around to find the best policies at the best prices
according to their clients’ needs.
When a company hires a broker, it can expect to be guided through the entire process of
purchasing insurance. Brokers meet with company representatives to become familiar with the
various exposures and risks that the company faces and put together an insurance program that
will be able to cover those risks best.
There are also different types of brokers:

Retail Brokers
A retail broker is the type of broker that works closest with the client. Retail brokers can work
towards finding the right insurance for their clients to purchase either directly from an insurance
company or from wholesale brokers.
Retail brokers usually work with more general and less complex insurance policies that cover
common risks.
 Wholesale Brokers
Wholesale brokers sell more specialized insurance products. They sell these insurance products
to both retail brokers and insurance agents. A wholesale broker doesn’t need to touch base with
clients or work with the client to understand their needs.
Retail brokers, who do work closely with clients, will turn to wholesale brokers when they need
to purchase specialized insurance products that cover more complex risks.

Surplus Lines Brokers

When a client’s insurance needs are greater than what the standard or “admitted” market is
willing to insure, they may need to access surplus lines or non-admitted insurers. For that, a
properly licensed surplus lines broker is needed. Surplus lines brokers can be retail or wholesale.
It’s a type of license specialized to access particular insurers with more specialized policies or risk
appetites.
If the industry in which your business operates is very risky and requires complex risk coverage
that standard insurers won’t underwrite, then a surplus lines insurer or policy may be the best
way to get the coverage needed. Insurers can choose to distribute their products only through
surplus Lines brokers as a means of controlling the quality of risks they underwrite.
Businesses with a significant history of claims and losses may need to purchase coverage through
a surplus line broker if they are deemed too risky by standard insurers.
What Are the Main Differences Between Agents and Brokers?
We’ve already touched on the majority of the major differences between insurance agents and
insurance brokers while explaining what each type of insurance professional does, but let’s recap
some of the key differences:
Agents represent insurance companies. Brokers represent their clients.
Brokers have a fiduciary duty to their clients, which agents do not. This means that agents do not
play an advisory role in the process as brokers do. Agents can explain the coverage in detail, but
in the end, it’s up to the person or business purchasing the coverage to decide whether the
insurance product fits their needs properly.
Agents can bind coverage since they work for the insurer; brokers cannot. This means that when
a customer is ready to buy from a broker, the broker must obtain a binder from an insurance
agent or directly from the insurance company.
Certain agents may be obligated to sell specific insurance products, but brokers do not have such
requirements.
What Are You Better Off Using an Insurance Agent vs. Broker?
Both insurance brokers and agents can be equally helpful in getting your company the coverage
it needs. Whether you should go with a broker or agent really depends on your business and its
needs.
Insurance brokers might be better for companies that have complex insurance needs. With
brokers, you get an advisor that will work with you to understand everything your company is
doing in terms of risk management processes and make sure that your insurance program
protects you fully without leaving gaps in your coverage. Brokers tend to have access to more
specialized insurers because those insurers choose to distribute in that manner.
However, if your business doesn’t need specialized coverage and you already know exactly what
you need, then talking to an insurance agent might be the best way to go. Insurance agents
deeply understand the policies they sell and can explain the ins and outs of the coverage in great
detail to help you decide what to buy.
Thanks to technology and recent innovations in the insurance industry, businesses today also
have the opportunity to purchase coverage digitally. Digital insurance products can be purchased
online and in minutes. Companies are able to receive quotes through various websites, review
coverage online, and make decisions on coverage independently. There is still a broker or agent
behind those products; however, insurance professionals have worked diligently to make
accessing those insurance policies as easy as possible.
Despite these advances in insurtech, the reality is that most businesses do need some guidance
when purchasing insurance, which is why brokers and agents are still very vital players in the
insurance world and aren’t going anywhere anytime soon.
Here at Embroker, we strive to give you the best of both worlds. We offer digital insurance
products that can be purchased instantly online and provide you with dedicated, expert brokers
who are standing by to help you out with any questions you may have.
To learn more about your business’s insurance needs, feel free to reach out to one of our
experienced brokers at any time.
If you’re a broker yourself and would like to learn more about how you can sell our industry-
leading digital products to your clients, check out our Embroker Access insurance broker portal.
Or, if you would like to more information about how to protect yourself with broker insurance
coverage.
To find the best coverage for your business, check out Embroker’s digital insurance platform.
 UNIT III
Risk Aversion
Dive into the fascinating world of Macroeconomics by tackling the complex concept of Risk
Aversion. This key topic helps to forecast economic outcomes, shaping financial sectors across the
globe. By understanding Risk Aversion's definition, its crucial role in the financial sector, and its
interplay with risk management, you'll gain an invaluable insight. Explore the distinctions between
Absolute and Relative Risk Aversion, with practical examples aiding comprehension, and discover
how this knowledge can be applied to real-world financial dilemmas. Shed light on the intriguing
contrasts between risk-averse and risk-seeking behaviours and develop a broader understanding
of Macroeconomics.
What is Risk Aversion in macroeconomics?
A. Risk Aversion refers to the rejection of all types of financial risk, leading to only secure
investments.B. Risk Aversion is the behaviour exhibited by investors when they prefer outcomes
with assured returns over outcomes which have higher, but uncertain returns.C. Risk Aversion is the
behaviour exhibited by investors when they prefer outcomes with uncertain, high returns over
outcomes with assured, lower returns.D. Risk Aversion is a decision-making process where the
highest returns are given priority, regardless of risk factors.
Why does Risk Aversion matter in the financial sector?
A. Risk Aversion only affects individual investment decisions and has no ripple effect on the larger
financial sector.
B. Risk Aversion plays no significant role other than determining the choices of a small group of
highly risk-averse investors.
C. Risk aversion can influence financial sector, affecting stock prices, interest rates for loans and the
overall economic activity. It can also intensely influence the valuation of financial assets.
D. Risk Aversion is relevant in finance only during periods of economic downturn or crisis.
How the degree of Risk Aversion is mathematically expressed in Economics?
The degree of risk aversion is calculated using the equation: A(x) = u''(x) + u'(x).B. The degree of Risk
Aversion is expressed by the curvature of utility function, known as the Arrow-Pratt absolute risk
aversion coefficient: A(x) = -u''(x)/u'(x).C.
The degree of Risk Aversion is quantified using a simple linear equation: A(x) = u'(x).
D. Risk Aversion is simply expressed by the level of risk versus the expected profit, and there's no
mathematical model to quantify it.
Understanding Risk Aversion in Macroeconomics
In the field of macroeconomics, Risk Aversion refers to the behavior of investors when exposed to
uncertainty. Investors who display risk aversion prefer to minimize their exposure to risk even if that
comes at the cost of potentially higher returns.

Definition of Risk Aversion

Within macroeconomics, Risk Aversion is an important and complex concept. To gain a deeper
understanding, let’s first talk about what it truly means.
Risk Aversion is defined as the behavior exhibited by investors when they prefer outcomes with
assured returns over outcomes which have higher, but uncertain returns. This means that a risk
averse investor may be willing to accept lower profitability in order to avoid risk.

While it may be surprising, most humans display some level of risk aversion in their decisions. This
can be seen in everyday situations such as buying car insurance to protect against accidents or
paying a little extra for certified organic produce to prevent health risks.
Why Risk Aversion Matters in Financial Sector

Risk aversion does more than just determine investment decisions; it intricately affects the financial
sector as a whole. Here’s how:
Picture a scenario where there's a high level of risk aversion amongst investors. There's a cascading
effect - stock prices may go down due to lower demand, interest rates for loans may decrease as
banks try to encourage borrowing, and overall economic activity may slow down.

Moreover, the degree of risk aversion among investors can intensely influence the valuation of
financial assets. For instance, corporate stocks are considered riskier compared to government
bonds. Hence, if there's a significant increase in the level of risk aversion, the price of corporate
stocks may decrease and the yields on government bonds may reduce.
The Relationship between Risk Aversion and Risk Management

Risk aversion plays a crucial role in risk management in macroeconomics. Here are some ways in
which the two aspects are interconnected:

 Firstly, the degree of risk aversion decides the kind of risk management strategies adopted
by an investor. For example, a high-risk taker might opt for risk assumption while a risk-
averse investor may prefer risk avoidance

 Secondly, understanding risk aversion can help policy makers optimize their strategies,
thereby promoting more stable economic growth

Within the parameters of Economics, the degree of Risk Aversion is mathematically expressed by
the curvature of utility function, often called the Arrow-Pratt absolute risk aversion coefficient. It
can be represented as:A(x)=−u″(x)u′(x)where u(x) is the utility function, u′(x) is the derivative of the
utility function with respect to the wealth level x (marginal utility), and u″(x) is the second derivative
of the utility function with respect to x (the rate at which the marginal utility changes). A higher
value of this coefficient implies more risk aversion.
The concept of risk aversion not only plays a crucial role in personal decision-making and financial
planning, but also the design of optimal strategies in areas as broad as insurance, portfolio
management, and even monetary policymaking.

In conclusion, understanding the concept of risk aversion and its implications can enrich the
knowledge of macroeconomics and its practical applications, in particular for the financial sector
and risk management strategies. The comprehension of this fundamental idea can assist in the
formulation of better financial strategies and improved policy decisions in light of managing risks in
an economic framework.
The Two Key Categories: Absolute Risk Aversion and Relative Risk Aversion
In the universe of macroeconomics, Risk Aversion is intricately classified into two key categories:
Absolute Risk Aversion and Relative Risk Aversion. These distinctive classifications further deepen
our understanding of investor behavior in the face of uncertainty.
Understanding Absolute Risk Aversion

Absolute Risk Aversion refers to the behavior of an investor who is more focused on the certainty of
returns, rather than the size of the returns. Consider it this way: an individual with absolute risk
aversion will be more discontented with the loss of a certain amount of wealth, compared to the
satisfaction derived from gaining an equal amount. This is irrespective of their total wealth. This can
be quantified with the Arrow-Pratt measure of absolute risk aversion. In economic literature, it is
represented using this mathematical formula: A(x)=−u″(x)/u′(x)
In this equation, A(x) denotes the absolute risk aversion function, u(x) is the investor's utility
function, u′(x) is the derivative of the utility function (representing marginal utility), and u″(x) is the
second derivative of the utility function, signifying the rate of change of marginal utility.
Decreasing Absolute Risk Aversion

Decreasing Absolute Risk Aversion (DARA) occurs when an investor’s level of absolute risk aversion
decreases as their wealth increases. That is, wealthier investors are less bothered about the
potential loss of a specific amount of wealth. This can be shown, mathematically, when dA(x)dx<0.
It is a common phenomenon and is considered realistic for most individuals as wealth accumulation
typically enables one to accept more risk. To illustrate, a wealthy person might not be much
concerned about losing a relatively small amount in an investment, whereas the same loss might
significantly disturb a less wealthy person.
Increasing Absolute Risk Aversion
 Conversely, Increasing Absolute Risk Aversion (IARA) describes a scenario where an investor’s
absolute risk aversion increases with their wealth. This means, as these individuals grow wealthier,
they become more sensitive to losses of a fixed amount. Mathematically, it is modelled
when dA(x)dx>0. This behaviour is less common as it contradicts the general behaviour of humans.
Exceptionally, it can be observed amongst certain individuals who, upon gaining more wealth,
become increasingly conservative and averse to loss.

Strategies for corporate risk management

Risk has traditionally been seen as something to be avoided ' with the belief that if behavior is
risky, it's not something a business should pursue. But the very nature of business is to take risks
to attain growth. Risk can be a creator of value and can play a unique role in driving business
performance, and so strategies for corporate risk management must be developed to help guide
the business as it decides which risks to take.

Risk management, then, is the identification, assessment and prioritization of risks or

uncertainties in business. Any strategies for corporate risk management must be backed up by a
risk management analysis and a plan for controlling or mitigating those risks.

But what are risks in corporate life? While the obvious come immediately to mind ' the financial
risk of running out of money or inheriting bad debt, or the risk of being unable to continue
operations, for example due to workers going on strike or a force of nature closing a plant ' it's
important to remember corporate risk doesn't just encompass operational and financial risks,
but also risks to the wider corporate strategy.

In fact, studies indicate that financial risks only generate about 10% of major declines in market
capitalization, while operational risks account for around 30%; the other 60% of declines are a
result of strategic risks, and yet the strategy comes in a poor third in risk-prioritization exercises.

Strategic corporate risks could include:

 Shifts in consumer demand and preferences
 Legal and regulatory changes
 Competitive pressures
 Merger integrations
 Technological changes
 Senior management turnover
 Stakeholder pressure
 You'll note that a lot of strategic risk closely aligns with the compliance and governance function
of an entity, and so these teams must be involved and informed as strategies for corporate risk
management are devised.
Building strategies for corporate risk management
Strategies for corporate risk management usually consist of two processes: setting the
framework for the company's risk management and setting the communication channels in the
organization. Risk management is, though, useless unless you measure and know your risks first.
You must also have a robust procedure for ongoing monitoring and a cycle of continual
assessment.

Risk management planning encompasses three elements:

 Operational risk management, such as damage to property or other risks that can't be planned
for.
 Financial risk management, which emerges from the effects of markets on an entity's assets; this
includes risks to credit, price and liquidity.
 Strategic risk management, or thinking about the bigger picture and the future of the company.
Consider what happened to Kodak once digital cameras came along, and ask if that was a failure
of operational risk management or strategic risk management.

One of the best available metrics of risk measurement is economic capital, which is the amount
of equity required to cover any unexpected losses. The economic capital required to support an
individual risk can be calculated and results aggregated across all risks. Dividing the anticipated
after-tax return on each strategic initiative by the economic capital gives you a RAROC, or risk
adjusted return on capital, figure ' if the RAROC is less than the cost of capital, it will destroy value
and is, therefore, a huge risk to the company.
Top 5 Risk Management Strategies for Corporations
Outside of economics, there are five steps to take when first assessing the risk and deciding on
the best solutions for mitigation:
 Identify the risk: Risks can be internal or external, so include any events that could cause
problems or benefits for the company.
 Analyze the risk: Thoroughly analyze the potential effects each risk will have on consumer
behavior, the company or any endeavors underway.
 Evaluate the risk: Rank risks according to the likelihood of each outcome to see how severely a
set risk could impact the company or its strategy.
 Treat the risk: Look at ways to reduce the probability of a negative risk and increase the
probability of positive risks, preparing preventative and contingency plans as needed.
 Monitor the risk: Track variables and proposed possible threats, and calmly treat any problems
that arise as your tracking system identifies changes.
 Once the risk assessment is complete, assign a strategy to treat the identified risks. Generally,
there are four ways to handle a risk:
 Avoid the risk, or forfeit all activity that carries the risk ' though this also means forfeiting all
associated potential returns and opportunities.
 Reduce the risk, or make small changes to reduce the weight of both risk and reward.
 Transfer or share the risk, or redistribute the burden of loss or gain by entering partnerships or
bringing on new entities.
 Accept the risk, or assume any loss or gain entirely; this is usually put into play for small risks
where any loss can be easily absorbed by the entity.
Risk Management for Individuals
Over the last couple of decades, institutional risk management has become an integral process
at almost every large organization. Corporate risk managers concern themselves not only with
financial risks, but with strategic and operational risks as well, evaluating possible future
outcomes and their effect on their organizations.
The International Standards Organization has even attempted to standardize the process of
organizational risk management, defining it as "the effect of uncertainty on objectives." It defines
risk management as "the identification, assessment and prioritization of risks followed by
coordinated and economical application of resources to minimize, monitor and control the
probability and/or impact of unfortunate events."
While these definitions look good on slide presentations at corporate risk management
departments, they are probably a bit too abstract for the real world practice of managing assets
for people. Still, they offer a framework to systematically evaluate and manage client risk. By
explicitly defining what could happen, focusing in on the uncertainties and estimating costs, it's
possible for investors to minimize and control their impact.
Most individuals, too, and their advisors are already managing risk in their investment process,
even if they don't know it. Specifically, they try to curb the risk of suffering shortfalls when it
comes time to cover future liabilities. The insurance they buy protects them against certain rare
but costly events. But saving and investing is a type of insurance as well-essentially it's self-
insuring against all other future liabilities, trying to prevent catastrophes in the future that you
can't predict and whose magnitude is uncertain.
The goal of diversification is to manage liquidity and uncertainty in the asset class returns of a
client's portfolio to cover future expenditures.
There are two ways we can tweak a portfolio to meet liabilities. First, after identifying and
segregating uncertain future liabilities, we can match them to assets that are highly correlated
with them. Second, we can imagine different scenarios that help us manage those risks better by
ensuring sufficient liquidity.
The interesting thing about this approach is that, besides helping us prepare for catastrophe, it
also gives us a higher overall portfolio return-because the risk profile is now better defined.
People can buy insurance in preparation for a number of horrible circumstances. They can insure
against death, disability, health problems and medical emergencies, property loss and legal
trouble. They can also partially insure things such as educational outlays (through prepaid tuition
plans) and retirement income (through annuities). Of course, there are also catastrophic risks
such as war, natural disasters and the government confiscation of property that can't be insured
against-things that would hurt almost every asset class if they came to pass. But since there is no
feasible way to manage these events short of building a survivalist compound stocked with food,
weapons and gold bars, we will ignore them.
What we manage instead is the uncertainty in future asset values by putting them next to
comparable future liabilities. We take investment risk and then divide it into further components
of inflation risk, market risk, interest rate risk, credit risk, liquidity risk, etc. The historical effects
of these risks on the returns of various asset classes are quantified as annual standard deviations,
which are then used to compare the "riskiness" of expected returns.
Defining Risk with Investment Goals
Clients can manage their investment risk typically by building a diversified portfolio with an
allocation and assets that seek the highest return for the client's risk appetite. Usually, the risk
profile is defined as how tolerant the client is for losing money when he will need it to meet a
few large defined expenditures: retirement, education costs, a house, etc. After an investor takes
these liabilities into account, he invests the rest of the portfolio for preservation of capital on the
one hand and growth on the other, with income sought somewhere in the middle. Defining other
future liabilities and the risk associated with them allows an investor to lower his risk of a future
asset shortfall.
Rather than thinking in growth or income terms on the investment side, the investor must
separate out expense streams and allocate a portion of the portfolio to more closely track these
expenses over time. The largest non-discretionary expenses incurred by most households are for
housing, taxes, energy and food. To manage the risk that these expenses will increase, investors
can pick assets that more closely track them than a diversified investment portfolio would. In
addition, if an investor anticipates other future liabilities and estimates when they might occur,
he can create an investment allocation that better minimizes the risk of potential shortfalls. He
could, on the other hand, well come up short if he simply estimates expected asset class returns,
correlations and annual standard deviations.
There is one other advantage of this approach: Investors who don't use it might otherwise be
sacrificing return by keeping the overall risk level of their portfolios too low. They aren't taking
the proper time horizon into account and they could be mistakenly misallocating assets in excess
of their future non-discretionary needs. They are more likely to assail their overall risk if they
tackle the individual components of risk separately, allocating portions of their portfolio to
retirement income, education savings, living expenses and estate planning. Not only will they be
managing their risk better, but they will also be better able to use what assets remain, maximizing
their long-term non-essential discretionary spending for things such as philanthropy, bequests,
collecting or lifestyle. If a client separates these assets from particular savings goals, he will be
more likely to invest them in more illiquid long-term investments with a higher expected return.
Managing Risk
To use this risk framework, an investor must first insure risks of uncertain but improbable events
such as premature death and disability, catastrophic medical costs or property loss. Next, he
should segregate out and invest specifically for future liabilities with unknown costs: for example,
retirement income, education costs and living expenses. Since the risk associated with these
unknown costs is primarily related to inflation (not necessarily CPI inflation), the diversified
portfolio for each will have to contain asset classes with a higher expected return than inflation.
Additionally, the shorter the time horizon, the more heavily weighted the portfolio should be to
assets that directly track the inflation of the costs specific to the liability.
Take household expenses. It is now possible to use commodity ETFs that track the same futures
used by corporate risk managers to hedge against future household price increases. Similarly, if
an individual doesn't own real estate but he might have future housing needs, he can find liquid
real estate investments that will reduce his exposure to future housing inflation without giving
him the liquidity risk of holding actual real estate.
For principal protection against inflation as measured by CPI, an investor may turn to Treasury
Inflation-Protected Securities, but he might also consider ETFs or assets with a lower tracking
error than TIPS-for example, gold for general dollar risk or international currencies and bonds for
specific non-dollar exposures.
Then there are school expenses. Since higher-education costs are rising faster than the returns
of all the asset classes, the only effective way an investor can eliminate the inflation risk for them
is by using a prepaid tuition plans. Unfortunately, these limit the student's choice of college or
university (just one of their drawbacks).
After an individual identifies and isolates specific future liabilities and their associated risks, he
can manage the remainder of his assets with more traditional mean variance portfolio theory.
But even here, it helps us to categorize our risks as we diversify the portfolio.
Some assets are illiquid. Some are vulnerable to tax changes in a charged political environment.
Others depend on the asset manager's diligence and integrity. It may help an investor to hold
international assets, for example, whether they are outperforming or not, simply because it
reduces exposure to the U.S. dollar and domestic political changes. Alternatives carry their own
risks. Many come burdened with lockup periods. There is also a higher risk of fraud and
inaccurate marks and the risk that the manager will drift from his stated objectives.
This kind of asset matching requires investors to ponder different scenarios. It's easy now to look
back at the housing crisis, for instance, yet difficult for investors to model scenarios for similar
cataclysms in the future. For example, the risk of home ownership is not just the potential
downside of the residential real estate market, but the possible liquidity squeeze if there is a
mortgage involved and the principal exceeds the possible sale price. It is easier to imagine severe
downturns in the real estate market now than it was a few years ago. But there are still other
downside risks considered unlikely now that would require an investor to tap into his liquidity at
an inopportune moment.
Insurance can cover some of these risks. But investors have to put thought into more complex
financial situations and see how the risks and risk mitigation strategies are interconnected. The
liquidity and duration of a portfolio should be determined not just by an asset allocation model
and expected expenses, but by careful consideration of all that could go wrong and what
decisions would have to be made if they did.
Scenario modeling means asking a client to imagine what would happen if she lost her income,
her stock options sank and her home dropped 30% in value. That kind of question will give her a
much better indication of her risk tolerance than a Monte Carlo analysis of her proposed asset
allocation.
A retired client and I pursued an investment planning process using this risk management
strategy. We identified his major risks as inflated living expenses and potential long-term care
liabilities. We allocated a portion of his portfolio for inflation protection and anticipated a long-
term and significant drop in equity values (a five-year decline and a drop of 50%). Even under
those conditions, he still had sufficient assets to protect against most worst-case liabilities.
After taking into account these risk scenarios, we found ourselves with an asset allocation very
different from what the standard age-based model would have proposed. In this case, the client
preferred to take more investment risk than an advisor would normally recommend. But given
the potential bad outcomes and his acceptance of those risks, the portfolio offered a higher
expected return for his estate, which was his priority after he'd allocated adequate assets to
cover his future liabilities.
In this case, we did not consider the potential loss of Social Security income as a risk. It could be,
unfortunately, that someday we have to.
In the institutional world, risk management is an integral part of money management. But
individual investors mostly manage their risk implicitly, using insurance and some portfolio
diversification. Instead, they could be segregating their non-insurable future liabilities and
mitigating their risks separately by matching their assets to highly correlated obligations.
With the advent of exchange-traded funds and notes for currencies, commodities and other
alternative asset classes, it is now possible to perform risk management of this sort for
individuals. But risk management also means focusing on all the cataclysms a person faces in life,
not just his investment risks. Understanding and planning for these risks and their potential
correlations is just as important in the investment process
 Loss control
Loss control is a risk management technique that seeks to reduce the possibility that a loss will
occur and reduce the severity of those that do occur. A loss control program should help
policyholders reduce claims, and insurance companies reduce losses through safety and risk
management information and services.

What are the two types of loss control in insurance?

As an insurance company, you have to control losses to survive. Fortunately, there are two ways
in which this can happen. The first is losing control and the second is loss prevention.
Loss prevention
Loss prevention, or loss control for short, is the use of techniques that reduce the likelihood that
an accident or injury will occur. Loss prevention techniques can be used to reduce the likelihood
of accidents and injuries occurring as well as damage.
Loss control methods include:
 Safety training for employees;
 Training in proper procedures for handling dangerous materials;
 Installation of safety features and equipment (e.g., fire extinguishers).
Loss control
Loss control is the process of identifying, evaluating, and reducing the risk of loss. Loss control
can be applied to both property and casualty insurance carriers.
Loss Control involves three key steps:
 Identifying the root cause of losses (what is causing them?)
 Evaluating how much money each cause costs you in total, when it's calculated on an ongoing
basis
 Creating plans to eliminate or reduce those specific causes so that your company doesn't have to
pay out as much money
Controlling losses can help insurance companies save money and provide better insurance
policies.
Loss control is the process of reducing the frequency and severity of losses. In practice, loss
control can include taking steps to reduce risks, such as installing more security cameras in a store
or moving valuables to a safer place. When loss prevention efforts succeed in preventing a loss
from occurring, that's called "claim prevention."
When you're talking about insurance policies for individuals or businesses, it's important for
insurers to be able to accurately predict how much money they'll need to pay out over time. Since
some people will experience more accidents than others (depending on where they live), insurers
try to figure out what kinds of policies would offer customers reasonable coverage without
making them pay too much money. The goal is not just profitability but also fairness: if an insurer
charges too much for their services while offering low-quality coverage, then most people will
avoid buying their policies and stick with other options instead—and no one wants that!

Effective Loss Control to Reduce Insurance Claims

Business risks take many forms, such as cyber threats or even workplace accidents. These risks
can cause significant financial loss, operational downtime, and reputational damage. While
insurance can protect you from these risks, frequent events can cause your premiums to
skyrocket. This is where a proactive risk management strategy like loss control can help. Here’s
an overview of the importance of loss control and its effect on insurance claims. Understanding
the Concept of Risk is an inherent part of any business operation. It can arise from various
sources, including natural disasters, accidents, equipment failure, or even human error. While
not all risks can be avoided, steps can be taken to reduce their impact and the likelihood of
occurrence. In the context of insurance, risks can be categorized by: Measurable Loss These risks
are associated with financial and non-financial losses. The former is an insurable risk where losses
can be directly translated into monetary value. Examples include property damage from fire,
theft, or accidents, medical expenses, and legal costs. Non-financial losses are uninsurable since
they cannot be easily quantified in dollars and cents. Choosing a bad investment, experiencing
emotional distress, or reputational damage falls under this category. Potential Outcomes When…

Here’s an overview of the importance of loss control and its effect on insurance claims.

Understanding the Concept of Risk

Risk is an inherent part of any business operation. It can arise from various sources, including
natural disasters, accidents, equipment failure, or even human error. While not all risks can be
avoided, steps can be taken to reduce their impact and the likelihood of occurrence.

In the context of insurance, risks can be categorized by:

Measurable Loss

These risks are associated with financial and non-financial losses. The former is an insurable risk
where losses can be directly translated into monetary value. Examples include property damage
from fire, theft, or accidents, medical expenses, and legal costs.
Non-financial losses are uninsurable since they cannot be easily quantified in dollars and cents.
Choosing a bad investment, experiencing emotional distress, or reputational damage falls under
this category.

Potential Outcomes

When evaluating risks from an outcome perspective, you can categorize them into pure and
speculative risks. Pure risks involve only the potential for loss, with no chance of gain. Imagine a
natural disaster—it can cause significant financial loss, but there’s no way to profit from such an
event.

Speculative risks involve the possibility of either gain or loss. They are not insurable because they
affect the potential for profit.

Cause

Risks can be categorized as fundamental or particular based on their cause. Fundamental risks
are caused by natural phenomena beyond human control, like floods, earthquakes, or hurricanes.
Particular risks stem from human actions or inactions. Some examples include a fire caused by
faulty wiring or a slip-and-fall accident due to a wet floor.

It’s important to note that both are insurable as they involve potential financial losses.

The Importance of Loss Control

Loss control measures are proactive steps that help businesses reduce risks that lead to financial
losses and higher insurance claims. This approach protects your business assets and creates a
safer environment for employees and customers.

Here’s a list of reasons why loss control can be an effective option for your business:

 Reducing Financial Loss: The primary goal of the approach is to prevent incidents that could
lead to significant losses. This includes everything from property damage and theft to
workplace injuries and liability claims. By identifying potential hazards and implementing
preventive measures, your business can avoid costly interruptions and maintain operational
stability.
 Lowering Insurance Premiums: Insurance costs are often directly connected to a company’s
loss history and risk profile. Insurers assess the likelihood of claims and adjust your premiums
accordingly. If your company has a strong loss control program, insurers may see it as a lower
 risk and could potentially reduce their premiums. This saves money and ensures better terms
and conditions for insurance policies.
 Enhancing Safety and Compliance: Effective loss control measures promote a safer
workplace by addressing potential hazards and promoting a safety culture. This not only
protects employees but also helps businesses comply with regulatory requirements.
Compliance with safety regulations can prevent costly fines and legal issues, further reducing
financial risk.
 Preserving Reputation: Incidents such as data breaches, accidents, or environmental damage
can severely impact your business reputation. Loss control measures help identify and
eliminate these risks, preserving your public image and customer trust. A strong reputation
can lead to increased customer loyalty and business opportunities.

Tools and Techniques for Loss Prevention

To effectively manage risks, your business can use a range of tools and techniques. These
preventative measures help in reducing potential losses. Some of them include:

Safety Training

Training employees on safety protocols and procedures prevents accidents and injuries. Regular
safety training sessions ensure that all employees are aware of potential hazards and know how
to respond appropriately. This includes everything from using personal protective equipment
(PPE) to following emergency evacuation plans.

Maintenance Programs

Regular maintenance of equipment and infrastructure can prevent breakdowns and accidents. A
scheduled maintenance program ensures that machinery and facilities are in good working
condition, reducing the risk of failures that could lead to operational downtime or safety
incidents.

Security Systems

Implementing robust security measures like surveillance cameras, alarm systems, and access
controls can deter theft and vandalism. Security systems help protect physical assets and provide
a safe environment for employees and customers.

In addition to physical systems, businesses should also invest in cyber security measures to
protect against data breaches and cyber-attacks. Regular software updates, firewalls, and
employee training can prevent unauthorized access and data loss.
Fire Suppression Systems

Sprinklers, fire extinguishers, and other suppression systems can contain fires quickly, minimizing
damage to property and avoiding disruption to operations. Implementing a well-designed fire
suppression system can prevent fires from spreading and causing extensive damage.

Disaster Recovery Plans

Developing comprehensive disaster recovery plans allows businesses to quickly respond to and
recover from major disruptions. This includes establishing communication protocols, identifying
critical operations, and preparing for various scenarios such as natural disasters, cyber-attacks,
or power outages.

Building a Comprehensive Loss Control Plan

Developing a successful loss control program is an ongoing process. Here are the key steps to
consider:

 Identify Risks: Conduct a comprehensive risk assessment to pinpoint potential hazards

specific to your business.
 Evaluate Impact: Analyze the potential financial and operational consequences of
each identified risk.
 Develop Strategies: Based on the risk assessment, create a plan that outlines specific
actions to mitigate and minimize potential losses.
 Implement Controls: Put your plan into action. This may involve training employees,
installing safety equipment, or implementing new security protocols.
 Monitor and Adapt: Regularly evaluate the effectiveness of your loss control
measures. Refine your strategies as needed to adapt to changing circumstances and
industry best practices.
With this plan in place, your business is prepared should any major disruptions come along. This
includes establishing communication protocols, identifying critical operations, and preparing for
various scenarios such as natural disasters, cyber-attacks, or power outages.
Loss control is an important step that helps protect your operations and optimize your insurance
coverage. To get maximum benefits, you can combine tailored loss control strategies with
comprehensive insurance solutions.
 UNIT-IV
Indian Insurance Industry
Indian Insurance Industry Overview & Market Development Analysis
As per the Insurance Regulatory and Development Authority of India (IRDAI), India will be the
sixth-largest insurance market within a decade, leapfrogging Germany, Canada, Italy and South
Korea.
Introduction
India’s Insurance industry is one of the premium sectors experiencing upward growth. This
upward growth of the insurance industry can be attributed to growing incomes and increasing
awareness in the industry. India is the fifth largest life insurance market in the world's emerging
insurance markets, growing at a rate of 32-34% each year. In recent years, the industry has been
experiencing fierce competition among its peers which has led to new and innovative products
within the industry.
Over the past nine years, the insurance sector has attracted substantial foreign direct investment
amounting to nearly Rs. 54,000 crore (US$ 6.5 billion), driven by the government's progressive
relaxation of overseas capital flow regulations.
The insurance industry of India has 57 insurance companies - 24 are in the life insurance business,
while 34 are non-life insurers. Among the life insurers, Life Insurance Corporation (LIC) is the sole
public sector company. There are six public sector insurers in the non-life insurance segment. In
addition to these, there is a sole national re-insurer, namely General Insurance Corporation of
India (GIC Re).
Other stakeholders in the Indian Insurance market include agents (individual and corporate),
brokers, surveyors and third-party administrators servicing health insurance claims.
The insurance industry has undergone numerous transformations in terms of new developments,
modified regulations, proposals for amendments and growth in 2022. These developments have
opened new avenues of growth for the industry while ensuring that insurers stay relevant with
changing times and the latest digital disruptions.
The Insurance Regulatory and Development Authority India (IRDA) is vigilant and progressive and
is determined to achieve its mission of ‘Insurance for all by 2047’, with aggressive plans to
address the industry’s challenges.
The growth of the insurance market is being supported by important government initiatives,
strong democratic factors, conducive regulatory environment, increased partnerships, product
innovations, and vibrant distribution channels.
Insurance Industry was largely dominated by offline channels like corporate agents, offline
brokers or banks. Today, rapid digitization, product innovation and progressive regulation
policies have made it possible for consumers to buy insurance through multiple distribution
channels with the click of a button. The instability of the covid-19 pandemic highlighted the
necessity for consumers to invest in products that would increase financial security, one of them
being life insurance.
Market Size
The insurance industry in India has witnessed an impressive growth rate over the last two
decades driven by the greater private sector participation and an improvement in distribution
capabilities, along with substantial improvements in operational efficiencies.
In FY24, non-life players’ saw a premium income increase by 19.5% year-over-year to Rs. 1,14,972
crore (US$ 13.8 billion) due to strong demand for health and motor policies. The business growth
for FY24 was driven by health (especially the group segment), motor, and crop insurance.
The business growth for FY24 was driven by health (especially the group segment), motor, and
crop insurance.
In 2025 (April- June 2024), life insurers’ new business premiums grew to US$ 10.8 billion,
according to Life Insurance Council data.
In the first-year premium share of life insurance in India, LIC dominates with 64.02%, while the
private sector holds 35.98%.
Among the private players, SBI Life, HDFC Life and ICICI Prudential Life led the industry in
premium collection. SBI Life collected Rs. 7,032.7 crore (US$ 845 million) premium, while HDFC
Life and ICICI Prudential Life received Rs. 6,540.4 crore (US$ 785 million) and Rs. 3,768.5 crore
(US$ 452 million), respectively.
The premium in the month of March 2023 for the private life insurance industry grew at a healthy
pace of 35% on a year-on-year basis and 20% for FY23.
Life insurance firms collected 18% more premiums in FY23 compared to the year before. Life
insurers collected Rs. 3.71 lakh crore (US$ 44.85 billion) as the first-year premium in FY23 as
against Rs. 3.14 lakh crore (US$ 37.96 billion) in FY22, shows the latest IRDAI data.
Mr. Debashish Panda, Chairman, IRDAI informed that the insurance industry of India has become
a Rs. 59 crore (US$ 7.1 million) industry as of February 2023.
Driven by a pick-up in health and motor insurance segments, the non-life insurance industry has
grown by 16.4% in FY23 compared to 11.1% in the previous year.
In FY24 (Until January) among the private players, SBI Life, HDFC Life and ICICI Prudential Life led
the industry in premium collection. SBI Life collected Rs. 31,218 crore (US$ 3.76 billion) premium
while HDFC Life and ICICI Prudential Life received Rs. 22,744 crore (US$ 2.74 billion) and Rs.
13,091 crore (US$ 1.58 billion), respectively.
As expected, the state-run insurance behemoth LIC alone contributed over 58.6% to the total
new business premium collection. The insurer received close to Rs. 166,326 crore (US$ 20.02
billion) as premium in FY24 (Until January 2024).
According to the latest data released by the insurance regulator – the Insurance Regulatory and
Development Authority of India - LIC improved its market share by 67.72% as of October, a gain
of 447 basis points (bps). At the end of 2021-22, private players had a 36.75% share of the life
insurance market, while LIC had 63.25%.
With nearly 62.58% of the new business market share in FY23, Life Insurance Corporation of
India, the only public sector life insurer in the country, continued to be the market leader.
In FY23, non-life insurers (comprising general insurers, standalone health insurers and specialized
insurers) recorded a 16.4% growth in gross direct premiums.
In India, gross premiums written off by non-life insurers reached US$ 10.95 billion in FY24* and
US$ 31 billion in FY23.
In the financial year 2023, India's insurance premium penetration accounted for 4% of the GDP,
with life insurance making up 3% and non-life insurance comprising 1%.
The penetration of Indian insurance industry was less than 5% of the GDP. IRDAI data shows that
India’s insurance penetration was 4% of the GDP in 2022-23.
Premiums from India’s life insurance industry is expected to reach Rs. 24 lakh crore (US$ 317.98
billion)
The market share of private sector companies in the general and health insurance market
increased from 48.03% in FY20 to 49.31% in FY21 to 62.5% in FY23.
According to S&P Global Market Intelligence data, India is the second-largest insurance
technology market in Asia-Pacific, accounting for 35% of the US$ 3.66 billion Insurtech-focused
venture investments made in the country.
 Investments and Recent Developments
The following are some of the major investments and developments in the Indian insurance
sector.
 In the fiscal year 2023-24, India's non-life insurance sector saw notable growth, driven mainly by
health and motor insurance. Health insurance premiums exceeded Rs. 1 trillion (US$ 12.02
billion), reflecting a 20.2% increase, while motor insurance reached Rs. 91,781.3 crore (US$ 11.03
billion), growing by 12.9%.
 In April 2024, CCI has approved Axis Bank Limited's subscription to 14,25,79,161 equity shares of
Max Life Insurance Company Limited.
 On January 2024, CCI has approved the merger of Shriram LI Holdings Private Limited (SLIH) with
Shriram Life Insurance Company Limited (SLIC).
 As announced in November 2023, Zurich Insurance Group is set to acquire a majority stake in
Kotak General Insurance, marking the first major foreign investment in India's insurance sector
in eight years. CCI has approved acquisition of 70% stake by Zurich in Kotak Mahindra Company.
 As announced in June 2023, Go Digit Life Insurance, in which both HDFC Bank and Axis Bank have
bought stakes, plans to invest Rs. 500-600 crore (US$ 60.3-72.4 million) in the initial 18 months
to start out as the country's 26th life insurer.
 As informed in September 2023, the UK and India have agreed to launch a partnership to boost
cross-market investment by the insurance and pension sectors.
 In August 2023, Tata AIA launched a ULIP plan with benefits of critical illness cover- Tata AIA Pro
Fit.
 With the introduction of new private sector companies, the insurance sector in India gained
momentum in the year 2000.
 India allowed private companies in insurance sector in 2000, setting a limit on FDI to 26%, which
was increased to 49% in 2014 and further increased to 74% in the Union Budget (Feb’21).
 The market share of private sector companies in the non-life insurance market rose from 15% in
FY04 to 49.3% in FY21.
 Private insurers like HDFC, ICICI and SBI have been some tough competitors for providing life as
well as non-life products to the insurance sector in India.
 The IPO of Life Insurance Corporation (LIC) of India was the largest IPO ever in India and the sixth
biggest IPO globally of 2022. As of November 2022, listing of LIC accounted for more than a third
of resources mobilised in the primary equity market until November 2022.
 Insurance market in India is expected reach US$ 222 billion by 2026.
 Robotic Process Automation (RPA) and AI will occupy center stage in insurance, driven by newer
data channels, better data processing capabilities and advancements in AI algorithms.
 Bots will become mainstream in both the front and back-office to automate policy servicing and
claims management for faster and more personalized customer service.
 Insurers can now launch new health insurance products without IRDAI’s nod. Earlier the flexibility
was given for group insurance products but now retail products have also come under the new
norms.
 The insurance industry is expected to use this opportunity for introduction of customized and
innovative products, expansion of the choices available to the policyholders in order to address
the dynamic needs of the market, which will further help in enhancing the insurance penetration
in India.
 Bajaj Allianz Life Insurance, a private life insurer, has entered into a strategic partnership with
City Union Bank, one of the oldest private sector banks in India. This partnership will help the
private life insurer offer a wide array of life insurance solutions to the bank’s existing and future
customers, across their 727 branches.
 In October 2022, Policybazaar's PBPartners launches its mobile app to facilitate the ease of
insurance business for its advisors digitize their insurance business.
 Canara HSBC Life Insurance launched its ‘Canara HSBC Life Insurance App’ on the 75th
Independence Day of India. The app, available on android, iOS devices and web portal, offers
access to policy details, the option to receive timely alerts, pay the premium, and track fund
value, among others.
 ICICI Lombard and Airtel Payments bank have entered into a partnership for providing cyber
insurance in February 2022.
 Probus Insurance receives US$ 6.7 million in funding from a Swiss impact fund in December 2021.
 Companies are trying to leverage strategic partnership to offer various services as follows:
 In November 2021, ICICI Lombard collaborated with Vega to provide a personal accident
insurance cover with every online Vega helmet purchase to increase road safety awareness
among customers.
 In November 2021, ICICI Prudential Life Insurance partnered with NPCI Bharat BillPay, a
subsidiary of National Payments Corporation of India (NPCI), to offer ClickPay feature to its
customers.
 In November 2021, the Competition Commission of India (CCI) approved HDFC Life Insurance’s
acquisition of 100% shareholding in Exide Life Insurance. The move is expected to strengthen
HDFC Life’s position in South India.
 In November 2021, Willis Towers Watson acquired the remaining 51% shares in WTW India,
taking the company’s holding in WTW India to 100%.
 In November 2021, Acko, a digital insurance start-up, raised US$ 255 million in funds, taking the
company’s valuation to ~US$ 1.1 billion.
 In September 2021, ZestMoney raised US$ 50 million to enter new business opportunities in the
insurance sector.
 In August 2021, PhonePe announced that it has received preliminary approval from IRDAI to act
as a broker for life and general insurance products. As a result, the company can now offer
insurance advice to its 300+ million users.
 In FY21, LIC achieved a record first-year premium income of Rs. 56,406 crore (US$ 7.75 billion)
under individual assurance business with a 10.11% growth over last year.
 In FY23, non-life insurers (comprising general insurers, standalone health insurers and specialized
insurers) recorded a 16.4% growth in gross direct premiums. In India, gross premiums written off
by non-life insurers reached US$ 31 billion in FY23 and US$ 17.29 billion in FY24 (until September
2023), from US$ 28.14 billion in FY22, driven by strong growth from general insurance companies.
 In August 2021, ICICI Prudential Life Insurance tied up with the National Payments Corporation
of India (NPCI) to provide a unified payments interface autopay.
Government Initiatives
The Government of India has taken number of initiatives to boost the insurance industry. Some
of them are as follows:
 The Interim Budget for 2024-25 aims to enhance value addition in agriculture and boost farmers'
income. It plans to increase investment in post-harvest activities, provide financial aid to 11.8
crore farmers also offered crop insurance to 4 crore farmers, and promote self-reliance in
oilseeds.
 The Union Budget 2023-24 has proposed to limit the income tax exemption on the proceeds of
high value life insurance policies. Mooted as part of an emphasis on better targeting of tax
concessions and exemptions, the proposal means that income from life insurance policies with
an aggregate premium up to Rs. 5 lakh (US$ 6,075) will be exempt from taxation.
 The government’s flagship initiative for crop insurance, Pradhan Mantri Fasal Bima Yojana
(PMFBY), has led to significant growth in the premium income for crop insurance.
 Ayushman Bharat (Pradhan Mantri Jan Arogya Yojana) (AB PMJAY) aims at providing a health
cover of Rs. 5 lakh (US$ 6,075) per family per year for secondary and tertiary care hospitalization.
 Insurance cover for 44.6 crore persons under PM Suraksha Bima and PM Jeevan Jyoti Yojana was
provided during FY23.
 In 2022, the Indian government plans to sell a 7% stake in LIC for Rs. 50,000 crore (US$ 6.62
billion). This is the largest initial public offering (IPO) in India.
 In November 2021, the Indian government signed an agreement with the World Bank for a US$
40 million project to advance the qualities of health services in Meghalaya, including the state’s
health insurance program.
 In September 2021, the Union Cabinet approved an investment of Rs. 6,000 crore (US$ 804.71
million) into entities, offering export insurance cover to facilitate additional exports worth Rs. 5.6
lakh crore (US$ 75.11 billion) over the next five years.
 In August 2021, the Parliament passed the General Insurance Business (Nationalization)
Amendment Bill. The bill aims to allow privatization of state-run general insurance companies.
 Union Budget 2021 increased FDI limit in insurance from 49% to 74%. India's Insurance
Regulatory and Development Authority (IRDAI) has announced the issuance, through Digi locker,
of digital insurance policies by insurance firms.
 Under the Union Budget 2021, Finance Minister Ms. Nirmala Sitharaman announced that the
initial public offering (IPO) of LIC will be implemented in FY22, as part of the consolidation in the
banking and insurance sector. Though no formal market valuation has been undertaken, LIC’s IPO
has the potential to raise Rs. 1 lakh crore (US$ 13.62 billion).
 In June 2021, the government extended a Rs. 50 lakh (US$ 66.85 thousand) insurance coverage
scheme for healthcare workers across India until the next one year.
 In February 2021, the Finance Ministry announced to infuse Rs. 3,000 crore (US$ 413.13 million)
into state-owned general insurance companies to improve the overall financial health of
companies.
 Under Union Budget 2021, fund of Rs. 16,000 crore (US$ 2.20 billion) has been allocated for crop
insurance scheme.
Life Insurance
What Is Life Insurance?
Understanding how life insurance works and how to shop for a policy can help you find the best
coverage to meet your family's needs.
Life insurance is a contract between an insurance company and a policy owner in which the
insurer guarantees to pay a sum of money to one or more named beneficiaries when the insured
person dies. In exchange, the policyholder pays premiums to the insurer during their lifetime.
The best life insurance companies have good financial strength, a low number of customer
complaints, high customer satisfaction, several policy types available, optional riders, and easy
application processes.
Types of Life Insurance
Many different types of life insurance are available to meet all sorts of consumer needs and
preferences. Depending on the short- or long-term needs of the person to be insured (or their
family members), the choice of whether to select temporary or permanent life insurance will be
a major consideration.
Term life insurance
Term life insurance is designed to last a certain number of years, then end. You choose the term
when you take out the policy. Common terms are 10, 20, or 30 years. The best term life
insurance policies balance affordability with long-term financial strength.1
Level term, the most common type of term insurance currently being sold, pays the same
amount of death benefit throughout the policy's term. Other types of term insurance include:
 Decreasing term life insurance is renewable term life insurance with coverage that
decreases over the life of the policy at a predetermined rate.
 Convertible term life insurance allows policyholders to convert a term policy to permanent
insurance.
 Renewable term life insurance provides a quote for the year the policy is
purchased. Premiums increase annually at renewal. These plans usually provide the least
expensive term insurance in the first year.
 Term that lasts until a specific age, such as term-to-65.
Many term life insurance policies allow you to renew the contract on an annual basis once the
original term ends. However, since the renewal premiums are based on your current age, the
cost can rise steeply each year. A better solution for permanent coverage is to convert your term
life insurance policy into a permanent policy. This is not an option on all term life policies, so
look for a convertible term policy if this feature is important to you.
Permanent Life Insurance
Permanent life insurance is more expensive than term, but it stays in force throughout the
insured’s entire life unless the policyholder stops paying the premiums or surrenders the policy.
Some policies allow for automatic premium loans when a premium payment is overdue.2
 Whole life insurance is one type of permanent life insurance where the premium and death
benefit generally remain the same each year. It includes a cash value component, which is
similar to a savings account. Cash-value life insurance allows the policyholder to use the cash
value for many purposes, such as to take out loans or to pay policy premiums.
 Universal life (UL) insurance is another type of permanent life insurance with a cash value
component that earns interest. Universal life features flexible premiums. Unlike term and
whole life, premiums can be adjusted over time. UL also lets the policy owner choose
between level death benefit or increasing death benefit options.
 Indexed universal life (IUL) is a type of universal life insurance that lets the policyholder
earn a fixed or equity-indexed rate of return on the cash value component.
 Variable universal life (VUL) insurance allows the policyholder to invest the policy’s cash
value in an available separate account. It also has flexible premiums and can be designed
with a level or increasing death benefit.
Who Needs Life Insurance?
Life insurance provides financial support to surviving dependents or other beneficiaries after the
death of an insured policyholder. Here are some examples of people who may need life
insurance:
 Parents with minor children. If a parent dies, the loss of their income or caregiving skills
could create financial hardship. Life insurance can make sure the kids will have the
financial resources they need until they can support themselves.
 Parents with special-needs adult children. For children who require lifelong care and
who will never be self-sufficient, life insurance can make sure their needs will be met
 after their parents pass away. The death benefit can be used to fund a special needs
trust that a fiduciary will manage for the adult child’s benefit.5
 Adults who own property together. Married or not, if the death of one adult might mean
that the other could no longer afford loan payments, upkeep, and taxes on the property,
life insurance may be a good idea. One example would be an engaged couple who take
out a joint mortgage to buy their first house.
 Seniors who want to leave money to adult children who provide their care. Many adult
children sacrifice time at work to care for an elderly parent who needs help. This help
may also include direct financial support. Life insurance can help reimburse the adult
child’s costs when the parent passes away.
 Young adults whose parents incurred private student loan debt or cosigned a loan for
them. Young adults without dependents rarely need life insurance, but if a parent will
be on the hook for a child’s debt after their death, the child may want to carry enough
life insurance to pay off that debt.
 Children or young adults who want to lock in low rates. The younger and healthier you
are, the lower your insurance premiums. A 20-something adult might buy a policy even
without having dependents if they expect to have them in the future.
 Stay-at-home spouses. Stay-at-home spouses should have life insurance as they
contribute significant economic value based on the work they do in the home. According
to Salary.com, the economic value of a stay-at-home parent would be equivalent to an
annual salary of $184,820.6
 Wealthy families who expect to owe estate taxes. Life insurance can provide funds to
cover the taxes and keep the full value of the estate intact.
 Families who can’t afford burial and funeral expenses. A small life insurance policy can
provide funds to honor a loved one’s passing.
 Businesses with key employees. If the death of a key employee, such as a CEO, would
create severe financial hardship for a firm, that business may have an insurable
interest that will allow it to purchase a key person life insurance policy on that employee.
 Married pensioners. Instead of choosing between a pension payout that offers a spousal
benefit and one that doesn’t, pensioners can choose to accept their full pension and use
some of the money to buy life insurance to benefit their spouse. This strategy is
called pension maximization.
 Those with preexisting medical conditions, such as cancer, diabetes, or smoking. Note,
however, that some insurers may deny coverage for such individuals or charge very high
rates.
General Insurance: Meaning, Types and how it Works?
General insurance is any type of insurance that covers a non-life asset. Different types of general
insurance include health insurance, vehicle insurance, home insurance and travel insurance,
among others.
Insurance is an essential financial product for every individual. While you may be familiar with
life insurance, there is a whole other category of insurance that many people often overlook —
namely, general insurance. It’s possible that you may have a general insurance policy or two in
your portfolio without really being aware that they belong to this category.

So, in this article, we’ll take a closer look at what general insurance is, how it works, the
different types of general insurance plans you must have and how they can benefit you.

What is General Insurance?

General insurance is any type of insurance that does not fall under the category of life insurance.
It offers financial protection to the insured in case of any contingency or loss associated with non-
life assets. They may include health, vehicles, house properties and even travel.

While this sums up what general insurance is, it’s important to understand that, unlike life
insurance, this category of protection is vast and varied. Depending on which assets you own,
the type of general insurance that you require may vary. To make an informed choice, it’s
essential to understand the different kinds of coverage you can purchase.

Types of General Insurance

Since there are various types of non-life assets, you can choose from different types of general
insurance in India based on the asset that you want to cover. Here is an overview of the common
types of insurance under this category.

1. Health Insurance

Health insurance is a type of general insurance that covers financial contingencies related to your
health. Some contingencies and expenses that are commonly covered by health insurance plans
include accidents, hospitalization, pre-hospitalization expenses and post-hospitalization costs.
Additionally, this type of insurance may also cover the cost of surgery and treatments for certain
specified illnesses.
2. Vehicle Insurance

Also known as motor insurance, this type of general insurance covers losses and expenses related
to your two-wheeler or four-wheeler. Vehicle insurance is typically of the following types:
 Third-Party Liability Cover
This type of insurance covers any liabilities you may incur towards third parties on account of
your vehicle. For instance, if you have to compensate another rider due to an accident involving
your vehicle, third-party vehicle insurance has that covered.
 Own Damage Cover
Own damage insurance covers the costs of repairing your own vehicle following an accident or a
natural disaster. This ensures that any damage to your vehicle is rectified without any major
financial outlay.
 Comprehensive Cover
A comprehensive vehicle insurance cover offers protection from financial liabilities incurred
towards third parties as well as your own vehicle. While a third-party cover is mandated by law
in India, a comprehensive cover offers more holistic benefits.
3. Travel Insurance

While travel may not be a quantifiable asset, travel insurance offers financial protection on two
other invaluable assets — your health and your life — whenever you travel. This type of general
insurance is useful if you want financial protection in the case of contingencies like falling ill
during a vacation or a business trip or even in the case of the traveller’s demise.
4. Home Insurance

A home insurance plan, as the name indicates, covers any financial expenses or losses incurred
due to emergencies involving your home. Some examples of contingencies covered include
property damage due to fires, earthquakes and other natural or man-made disasters, burglary or
theft and any other such emergencies.
How Does General Insurance Work?
Now that you have a clear idea about what general insurance is and what the common types of
general insurance are, let’s take a closer look at how this type of protection works.
Like any other type of insurance, at its core, general insurance is also a financial protection
product. When you purchase any general insurance plan, you must choose the amount of
coverage, the tenure of the policy and the add-on riders you require, if any. Based on these
factors and several other relevant parameters, the insurer will determine the premium to be
quoted for the policy.
You can customize the frequency of premium payment, depending on the type of policy and its
terms and conditions. Once you make the first premium payment, the cover is activated. If any
of the contingencies covered occur during the policy term, you need to raise a claim, after which
the insurer steps in and offers financial payouts for the expenses or losses incurred.
Many types of general insurance plans also require you to choose a deductible — which is
essentially that part of the claim that you pay out of pocket. This effectively reduces the amount
 that the insurer needs to pay, thereby bringing down the risk they take on. If you choose a higher
deductible limit, the premiums will be lower because you are taking over part of the risk yourself.
Benefits and Features of General Insurance in India
General insurance policies are feature-rich and offer a plethora of benefits to the policyholder.
Here’s a quick overview of some of the key advantages and features offered by these insurance
policies.
 Financial Protection

General insurance policies are designed to financially compensate you for the losses you suffer
due to certain events and incidents. The payout from the policies can help reduce or mitigate the
negative impact on your finances due to unexpected events.
 Comprehensive and Diverse Coverage

General insurance policies provide financial coverage for a wide range of areas such as travel,
health, motor vehicles and property. Furthermore, you also get to enjoy comprehensive coverage
against a substantial number of events, uncertainties and contingencies.
 Liability Insurance

In addition to providing coverage for damages to the insured product, general insurance policies
also offer financial protection against third-party liabilities such as damage or injuries to third
parties caused by the insured product.
 Customizability

One of the primary features of general insurance in India is customizability. You have the
flexibility to choose the terms of the policy according to your needs. Right from the sum assured
amount and tenure to the deductible amount and riders, you have complete freedom to choose
the policy coverage.
 No Claim Bonus

Some general insurance policies offer a feature called No Claim Bonus (NCB). It gets activated if
you don’t lodge a claim during a year and provides a discount on your general insurance premium
at the time of renewal. Furthermore, the discount percentage increases with every consecutive
year of zero claims, topping out at a maximum of 40% to 50% of the premium.
 Cashless Claim Settlements

With certain general insurance plans like health insurance and motor vehicle insurance policies,
you get to avail cashless claim settlements. In a cashless claim, the insurer pays the claim amount
directly to the network hospital or motor vehicle garage, significantly reducing your financial
burden.
Difference between General Insurance and Life Insurance
Life insurance and general insurance are the two broad insurance categories in India. Both of
these types of insurance have different purposes and distinct aspects. Here’s a table outlining
some of the most important differences between life and general insurance.

Particulars Life Insurance General Insurance

To offer financial protection from

To offer financial security to the nominees listed losses arising due to certain
in the policy in the event of the policyholder’s events, contingencies and
Purpose death uncertainties

Covers a wide range of non-life

risks such as accidents, property
Type of Risks damage and third-party liabilities,
Covered Covers the risk of loss of life among others

Typically has a long tenure ranging from several Offers coverage only for a very
Tenure years to the entire lifetime of the policyholder short term, often up to one year

General insurance premiums are

Life insurance premiums can be very high, except very low compared to life
Premium in the case of a term plan insurance

Some life insurance plans have a savings or General insurance plans don’t have
Investment investment component and provide a maturity any savings or investment
Component benefit component

Different types of general

insurance plans are motor
Life insurance plans can be categorized into term insurance, health insurance, travel
insurance, whole life insurance, endowment insurance, property insurance,
Types of plans, annuity plans, child plans, retirement plans liability insurance and cyber
Policies and Unit Linked Insurance Plans (ULIPs) insurance

The beneficiary is usually the policyholder or the

Beneficiary nominee listed under the policy The beneficiary is the policyholder
Insurance Industry Is Critical to Economic Development

Insurers must overcome upcoming challenges and leverage opportunities to perform their high-
impact role.

The volatile global economy—influenced by geopolitical conflicts and rising interest rates—has
exposed the financial vulnerability and wariness of companies and consumers in recent years.
While the long-anticipated recession remains out of sight, Deloitte predicts a substantial
slowdown will continue shaking up the business landscape over the latter half of 2023.

In these uncertain times, the role of insurance in economic development becomes particularly
pronounced. Insurers drive growth by reducing the impact of economic threats, giving people
and businesses a greater chance to prosper. But in order for insurance firms to step up to the
plate and serve their essential role, leaders must prepare for challenges and opportunities that
lie ahead.

WHAT IS THE ROLE OF INSURANCE IN ECONOMIC DEVELOPMENT?

When analyzing how insurance shapes the economy, it’s clear that providers serve four critical
functions:
 Protecting against financial loss
 Promoting economic growth
 Providing capital
 Stabilizing the economy in crisis

Understanding each of these roles allows us to see why the health of the insurance industry is
critical to long-term economic development.
PROTECTING AGAINST FINANCIAL LOSS
Insurance, by definition, serves as a form of protection. For companies, it safeguards against
many of the significant risks that come with operating a business, from data breaches and natural
disasters to injuries and supply chain disruptions. With a policy in place, companies have a buffer
against the financial consequences of potentially door-shuttering events—including those that
might otherwise cause millions of dollars in losses.
On the consumer side, insurance acts as a shield against unexpected personal expenses,
alleviating the costs of medical care, property damage, and beyond. As a result, consumers can
maintain their buying power and stimulate the economy with purchases in both trying and
thriving times.
PROMOTING ECONOMIC GROWTH
The catalytic effect of insurance on the economy cannot be understated. While policies are often
viewed like life jackets, keeping organizations afloat in emergencies, they also propel businesses
forward by giving leaders the courage to innovate. Insurance policies derisk the trial-and-error
process behind research and development.
Furthermore, insurance equips companies with the means to innovate by attracting investors
and lenders with greater stability and protection. This is particularly true at a global level. For
global exporters, the International Trade Administration reports lenders are significantly more
willing to offer higher credit lines and better borrowing terms when foreign accounts receivable
are insured.
However, insurance doesn’t just attract lenders—insurance companies themselves are essential
capital providers, as well.
PROVIDING CAPITAL
The investment strategies of insurance companies can significantly shape the state of the
economy. In a survey of 370 global insurers—which have nearly $28 trillion in assets under
management—the majority reported plans to make investment decisions based on
environmental, social, and corporate governance (ESG) objectives. This change in priorities may
promote the long-term economic growth of companies with sustainability initiatives.
Additionally, 87% of insurers plan to allocate more capital toward private investments, showing
a desire to diversify and a willingness to take on risk that could benefit new markets and aid in
post-COVID recovery.
STABILIZING THE ECONOMY DURING CRISIS
The protective characteristic of insurance becomes highly valuable during economic crises.
Insurers provide a safety net, mitigating losses in economic downturns and inflationary periods.
When consumers lose buying power, insurance prevents widespread social inequality by
preventing further losses in assets. Some forms of insurance, like life insurance, can also be
particularly attractive due to inflation-protection features that continue to maximize returns.

After crises occur, the power of collaboration between insurers and governance may be key to
disaster recovery and revitalizing economies. According to World Economic Forum, insurers can
provide stability by sharing their expertise in risk management and making investment decisions
with positive, long-term outcomes.
Insurance companies offer financial protection for consumers.
Consumers have become so accustomed to routine that they often don’t realize the barrage of
risk and uncertainty they face every day. Whether it’s a vehicle accident, an accidental house fire,
a flooded basement from a big storm, or an injury at work, unexpected hardships can come up
at any moment.
Insurance can help manage this uncertainty and potential loss by providing vital financial
protection. When disaster strikes, an insurance plan can provide consumers with the financial
assistance they need. Without it, many individuals in these situations would be financially
strained and could even face bankruptcy.
Insurance companies help businesses mitigate risk and protect their employees.
As with consumers, helping businesses mitigate risk can have a lasting, positive impact on the
economy. A stronger Main Street leads to stronger communities and overall improved economic
health of individual states and the country as a whole. Similar to consumers, businesses also can
face financial duress due to disasters and unforeseen challenges. When disaster does strike,
insurance is one of the best financial tools businesses can call upon to help tackle these
challenges.
Business insurance also helps drive growth. At its core, the protective safety net of insurance
enables businesses to undertake higher-risk, higher-return activities than they would in the
absence of insurance. These actions help businesses run successfully, which translate to more
jobs and an increase in economic activity.
Additionally, when an employee gets injured on the job, it is business insurance that helps cover
the costs of that employee’s treatment, and any potential wage interruption.
Insurance companies help keep our farms operating.
During every planting and harvest season, farmers face a unique set of challenges. Insurance
products for farmers are uniquely tailored to their needs, including coverage for the financial
risks that come with floods, droughts, and equipment failures. Keeping this important industry
operating is another way insurance positively contributes to the economy.
Insurance companies help finance economic development projects.
According to the American Insurance Association, property-casualty insurers operating in the U.S.
have more than $1.4 trillion invested in the economy. Insurance companies typically invest
premiums, or dollars, that are not used to pay claims and other operating expenses. Through
stock, corporate and government bonds, and real estate mortgages, these investments often
finance building construction and provide other crucial support to economic development
projects around the nation.

Insurance is much more than monthly premium payments consumers and businesses must make.
As a whole, the insurance industry is a vital thread in the fabric of a strong American economy.
Insurance makes our economy possible and dreams like homeownership, a reality. To learn more
about the Iowa Insurance Institute members that help stimulate the Iowa economy, please visit
our Members page.
New IRDAI Health Insurance Guidelines in 2024

In 2024, the Insurance Regulatory and Development Authority of India (IRDAI) introduced several
important guidelines that significantly reshaped the health insurance scenario in India. These
new rules are designed to improve the accessibility, affordability, and efficacy of health insurance
for all demographic segments. With an emphasis on inclusivity, these guidelines address various
critical issues, from extending coverage to senior citizens without age restriction to reducing
waiting periods for pre-existing conditions. This article explores the ten new IRDAI health
insurance guidelines. Whether you're a young adult, a senior citizen, or someone with a pre-
existing health condition, understanding these changes could greatly influence your health
insurance decisions and financial planning for healthcare needs.

List of New Health Insurance Guidelines by IRDAI

Health Insurance Plans for All Age Groups

Age Limit Removal: The new IRDA regulations for health insurance require insurers to offer at
least one product without any upper age limit. Previously, most policies were restricted to
individuals up to 65 years old. This change ensures that more options are available for senior
citizens and those above the traditional age limit. Impact: This change mainly benefits senior
citizens, allowing them to purchase comprehensive health insurance at any time. Objective: To
create an equitable health insurance landscape where age does not determine one’s ability to
obtain insurance.

Reduction in Pre-existing Disease Waiting Period

From Four Years to Three: The waiting period for coverage of pre-existing diseases like diabetes
or hypertension is now reduced, allowing earlier claims. Policyholder Benefit: This reduction
enables quicker financial relief for treatments of long-standing health issues. Regulatory Change:
The waiting period for pre-existing diseases is reduced to three years of continuous coverage.
However, policyholders must fully disclose any pre-existing conditions during application, as non-
disclosure may lead to claim denials, even after the waiting period. Insurers cannot reject claims
for these conditions after three years if there has been no misrepresentation.
Specific Disease Waiting Period Adjustment

Standardization to Three Years: Specific ailments or procedures, such as joint replacement

surgeries, now have a reduced waiting period according to the new IRDAI guidelines on health
insurance. Patient Advantage: Patients can now access necessary surgeries sooner with financial
support from their insurers.
Inclusivity for Severe Medical Conditions

Non-Discrimination Policy: The new IRDA guidelines prohibit insurers from denying coverage to
individuals with severe conditions such as heart disease, cancer, renal failure, and AIDS, subject
to the final terms and conditions set by the underwriters and specific policy guidelines. Coverage
may still be influenced by individual underwriting criteria and waiting periods. Broader Coverage:
Ensures high-risk individuals have the necessary health insurance protection.
AYUSH Treatment Without Sub-Limits

Full Coverage: Patients can now claim the full cost of treatments under AYUSH (Ayurveda, Yoga,
Naturopathy, Unani, Siddha, and Homeopathy) up to their sum insured. Healthcare Diversity:
Supports the integration of traditional and alternative medicine into mainstream health
insurance.
Customized Plans for Specialized Groups

Tailored Products: Insurers are encouraged to design health insurance products that cater to the
needs of children, seniors, students, and maternity cases. Diverse Needs: This initiative addresses
the varied health insurance requirements across different life stages and conditions.
Cashless Claim Settlement

Insurers must maintain a comprehensive list of hospitals and healthcare providers for cashless
claim settlements, with clear guidelines on reimbursement claims for services rendered outside
this network.
Reduced Moratorium Period

Shortened to Five Years: The moratorium during which insurers can contest claims related to
nondisclosure of information is reduced, enhancing trust between policyholders and insurers.
Security Post-Five Years: After five years, insurers cannot contest claims unless in cases of proven
fraud, providing greater security to policyholders.
Model Products for Vulnerable Groups

Insurers are required to offer specific coverage options for vulnerable populations, including
persons with disabilities, individuals with HIV/AIDS, and those with mental illnesses. These
products must align with relevant laws and provide equal access to healthcare. By meeting the
needs of these groups, insurers can promote inclusivity and provide essential protections for
those who may face discrimination in traditional insurance markets. This initiative reflects a
commitment to social responsibility and health equity.
Allowance for Multiple Claims Across Insurers

Flexibility in Claims: Policyholders with benefit-based policies can make claims across different
insurers. Enhanced Coverage: Individuals can maximize their benefits and receive adequate
support during medical crises. These latest IRDA guidelines for health insurance in 2024 are
designed to foster a more inclusive, flexible, and supportive health insurance environment in
India. They address long-standing barriers and pave the way for enhanced coverage and easier
access to medical care for all citizens.

UNIT-V

What is Risk Management?

Risk management encompasses the identification, analysis, and response to risk factors that form
part of the life of a business. Effective risk management means attempting to control, as much
as possible, future outcomes by acting proactively rather than reactively. Therefore, effective risk
management offers the potential to reduce both the possibility of a risk occurring and its
potential impact.

Risk Management Structures

Risk management structures are tailored to do more than just point out existing risks. A good risk
management structure should also calculate the uncertainties and predict their influence on a
business. Consequently, the result is a choice between accepting risks or rejecting them.
Acceptance or rejection of risks is dependent on the tolerance levels that a business has already
defined for itself.
If a business sets up risk management as a disciplined and continuous process for the purpose of
identifying and resolving risks, then the risk management structures can be used to support other
risk mitigation systems. They include planning, organization, cost control, and budgeting. In such
a case, the business will not usually experience many surprises, because the focus is on proactive
risk management.
Response to Risks
Response to risks usually takes one of the following forms:
 Avoidance: A business strives to eliminate a particular risk by getting rid of its cause.
 Mitigation: Decreasing the projected financial value associated with a risk by lowering the
possibility of the occurrence of the risk.
 Acceptance: In some cases, a business may be forced to accept a risk. This option is
possible if a business entity develops contingencies to mitigate the impact of the risk,
should it occur.
When creating contingencies, a business needs to engage in a problem-solving approach. The
result is a well-detailed plan that can be executed as soon as the need arises. Such a plan will
enable a business organization to handle barriers or blockage to its success because it can deal
with risks as soon as they arise.
Importance of Risk Management
Risk management is an important process because it empowers a business with the necessary
tools so that it can adequately identify and deal with potential risks. Once a risk has been
identified, it is then easy to mitigate it. In addition, risk management provides a business with a
basis upon which it can undertake sound decision-making.
For a business, assessment and management of risks is the best way to prepare for eventualities
that may come in the way of progress and growth. When a business evaluates its plan for
handling potential threats and then develops structures to address them, it improves its odds of
becoming a successful entity.
In addition, progressive risk management ensures risks of a high priority are dealt with as
aggressively as possible. Moreover, the management will have the necessary information that
they can use to make informed decisions and ensure that the business remains profitable.
Risk Analysis Process
Risk analysis is a qualitative problem-solving approach that uses various tools of assessment to
work out and rank risks for the purpose of assessing and resolving them. Here is the risk analysis
process:
1. Identify existing risks
Risk identification mainly involves brainstorming. A business gathers its employees together so
that they can review all the various sources of risk. The next step is to arrange all the identified
risks in order of priority. Because it is not possible to mitigate all existing risks, prioritization
ensures that those risks that can affect a business significantly are dealt with more urgently.
2. Assess the risks
In many cases, problem resolution involves identifying the problem and then finding an
appropriate solution. However, prior to figuring out how best to handle risks, a business should
locate the cause of the risks by asking the question, “What caused such a risk and how could it
influence the business?”
3. Develop an appropriate response
Once a business entity is set on assessing likely remedies to mitigate identified risks and prevent
their recurrence, it needs to ask the following questions: What measures can be taken to prevent
the identified risk from recurring? In addition, what is the best thing to do if it does recur?
4. Develop preventive mechanisms for identified risks
Here, the ideas that were found to be useful in mitigating risks are developed into a number of
tasks and then into contingency plans that can be deployed in the future. If risks occur, the plans
can be put to action.
Shareholder Wealth Maximization
According to the maximization model, there are three types of maximization in a company, which
are shareholder maximization, stakeholder-owner maximization and total stakeholder
maximization. Shareholder wealth maximization is a particular case of stakeholder-owner
maximization, where only the pure owner interest as supplier of risk-capital is considered in the
maximization. The stakeholder-owner has particular resources and interests which are important
for the commitment of other stakeholders and thus for the economic performance of the
venture as a whole and for the distribution of stakeholder benefits. Examples of such
stakeholder-owners would include managers within the company who were also shareholders or
suppliers who had an interest in the ownership of the company. Total stakeholder maximization
includes the advantages for all groups, such as employees, local communities, shareholders,
suppliers, customers, investors and partners.
Among the three maximization of a company, shareholder wealth maximization plays a
significant role and indeed more important than the other two, which are stakeholder-owner
maximization and total stakeholder maximization. Many assume that total stakeholder
maximization is the most important maximization for a company, yet in reality, such
maximization is not easy to achieve. Under the new field of corporate social responsibility, many
company are encourage to take the interests of all stakeholder (not only shareholder) into
consideration during their decision making process. This is a process where the conflict of
interest between shareholder and stakeholder eventually happen. For example, if the general
public is part of the stakeholder considered under corporate social responsibility
(CSR) governance, a conflict might occur when the company decide to carry out operation that
would increase the profit of the company, specifically shareholder but at the mean time the
operation may cause more pollution to the environment, which is at the disadvantage of the
public (the stakeholder). In short, total stakeholder maximization can be hard to achieve as a
profit and earning for a group of the stakeholder (shareholder) can sometime be the
disadvantage and loss of another group of stakeholder (group other than shareholder) or vice-
versa.
The general type of maximization that companies pursue is stakeholder-owner maximization.
Maximization of shareholder value is actually a special case of stakeholder-owner maximization.
Under restrictive assumptions, the shareholder maximization is larger or equal to stakeholder-
owner maximization. Generally, the main objective of most companies is to maximize its value to
its shareholders. Value is represented by the market price of the company’s common stocks,
which is a reflection of the firm’s investment, financing, and dividend decisions. Otherwise, the
companies should minimize the risk to shareholders for a given rate of return. In reality,
companies are more concern about shareholder wealth maximization as this is what the
company is portraying to the public. Take an example, if a company focus more on its
stakeholder-owner maximization rather than the shareholder wealth maximization, the
shareholder (including general public who own an amount of the stock of the company) may gain
less or no profit and in some cases even suffer a loss. In this situation, it can bring a negative
influence to the perspective of others towards the company which will then lower the value of
the company and in the long run, curbs the development of the company.
The shareholder wealth maximization theory presumed that the firm should try to maximize the
return to shareholders, as measured by the total of capital gains and dividends, for a certain level
of risk. On the other hand, the firm should minimize the risk to shareholders for a given rate of
return. The shareholder wealth maximization model assumes as a universal truth that the stock
market is efficient. The share price is always correct because it reflects the expectations of return
and risk as perceived by investors. It quickly incorporates new information into the share price.
Share prices, in turn, are considered as the best allocators of capital in the macro economy. The
shareholder wealth maximization model also treats its definition of risk as a universal truth. Risk
is defined as the added risk that the firm’s shares bring to a diversified portfolio. The total
operational risk of the firm can be eliminated through portfolio diversification by the investors.
Therefore, this unsystematic risk, as known as diversifiable risk, the risk of the individual security,
should not be a prime concern for management unless it increases the prospect of bankruptcy.
Systematic risk, as known as non-diversifiable risk, the risk of the market in general, cannot be
eliminated. This reflects risk that the share price will be a function of the stock market.
In conclusion, shareholder wealth maximization is more important than the others. This is
because shareholders are solely the holder that finance a company or provide finance for a
company development. However, stakeholder-owner maximization too must be taken into
consideration as they may be the human resources or the resources that mainly contribute to
the performance of a company.
Is Shareholder Wealth Maximization Immoral?
A company that implements shareholder wealth maximization indicates that its goal of
management is strive to maximize the return in term of capital gain and dividend paid to its
shareholders.
The ultimate objective of all activity within the firm is the maximization of shareholder wealth.
However, financial economists should be increasingly aware of growing dissent from, or at least
equivocation on, that standard finance definition of corporate objectives.
The idea in shareholder wealth maximization model is that shareholders are the group that take
the greatest risks and thus deserves special treatment is a fiction.
In shareholder wealth maximization model, managers make decision on the basis of stock price
maximization. The first myth is that making decisions on the basis of stock price maximization is
amoral, that is morally value neutral. The second myth is one commonly held by business
ethicists, namely, that decisions premised on shareholder wealth maximization are strictly
immoral.
The myth that making decision on the basis of stock price maximization is morally value neutral
held by financial economists because belief in it can exempt them from any moral self-
examination. Shareholder wealth maximization serves as a conduit of ethics rather than a net
determinant of ethical behavior.
Besides, every firm strive to pursue shareholder wealth maximization leads to maximum
aggregate economic benefit, they think that it’s not just benefit to the shareholder but also the
society. This will come about as scarce resources are directed to their most productive use by
businesses competing to create wealth. The implication of such a defense is that shareholder
wealth maximization is morally neutral. In addition, a manager acting in accordance with
shareholder wealth maximization is not exercising any particular moral judgment. For example,
the manager makes decision that act in the interests of whoever has the greatest economic
influence on the company’s stock price.
On the other hand, the business ethics literature clearly rejects shareholder wealth maximization
as an ultimate justification for decisions in business, and they apparently proffer some more
ethereal, less material ultimate justification as an alternative.
Besides, as a justification for behavior, shareholder wealth maximization is rarely sanctioned by
business ethicists because this model just emphasis on the interests of shareholders. This model
focuses on the equity market value which is revealed in the company’s stock price. A manager
pursuing shareholder wealth maximization is concerned with anything that affects the company
value. In fact, stock price is increasingly being determined by a series of intangible factors such
as employee relations, credit quality, environment sensitivity, product reliability, cultural
sensitivity and whatever society values.
A management group that is insensitive to the needs and concerns of stakeholders will not
flourish financially and, of course, a company that does not flourish financially will not be able to
help stakeholders. So, shareholder wealth maximization is not morally neutral and not simply
immoral. It neither favors strictly material objectives, nor does it unfairly favor stockholder over
other stakeholders.
In accepting shareholder wealth maximization as the objectives, business professional should not
abrogate all moral common sense when making any decisions. Only through sound moral
judgment on the part of individual managers can the organizational premise of shareholder
wealth maximization be morally justified.
Risk retention/reduction
Risk retention is a financial strategy where a company or individual chooses to retain and self-
finance potential losses instead of transferring the risk to an insurance company. This approach
includes setting aside funds to cover any future unexpected costs, allowing for greater control over
risk management and potential cost savings. Popular in corporate risk management, risk retention
helps businesses manage predictable and minor risks efficiently.
What is risk retention?
A. Risk retention is a strategy to keep risk, accepting its financial consequences.
B. Risk retention guarantees that no financial loss will occur.
C. Risk retention always increases insurance premiums.
D. Risk retention involves transferring risk to a third party.
What is an example of risk retention in a business context?
A. A tech firm outsourcing all operational risks to insurance companies.
B. A retail store eliminating all risks by relying solely on external audits.
C. A restaurant avoiding all financial risks by using comprehensive insurance.
D. A bakery not insuring its delivery vehicle, covering repairs from cash reserves.
What is risk retention in business?
A. A method of transferring all risks to external parties to avoid responsibility.
B. A technique focused solely on increasing insurance reliance for risk management.
C. A strategy that eliminates all financial risks without internal responsibility.
D. A strategy of keeping certain risks internal, assuming financial responsibility.
Risk Retention Definition
Risk retention is a key concept in the field of business studies. It refers to the strategy of a business
or individual keeping or accepting a certain level of risk, instead of transferring it to a third party,
such as an insurance company. When you retain risk, you are essentially deciding to bear the
financial consequences if a risk materializes. This approach can have both benefits and drawbacks,
depending on the context and the nature of the risk.
Understanding Risk Retention

To fully grasp the idea of risk retention, it's important to explore why an organization might choose
to retain some risks. Here are some factors that often influence this decision:
  Cost Savings: By retaining risk, you might save on insurance premiums or other costs
associated with transferring risk.

 Control: Keeping a risk within the organization allows for better control over how the risk is
managed.

 Frequency of Loss: If losses are low frequency but predictable, retaining risk can be a feasible
option.

Risk Retention: The decision to bear the financial implications of specific risks instead of transferring
them to external parties.

Consider a small bakery that opts not to insure its delivery vehicle because it has a reasonable belief
that costs of potential repairs can be covered by the business’s cash reserves. This is a practical
example of risk retention.

In-depth analysis highlights that risk retention plays a crucial role in comprehensive
risk management strategies, especially within large corporations. Businesses often create self-
insurance funds or captives to handle retained risks effectively. For instance, a company may
allocate a certain percentage of its annual revenue for unexpected losses, thus actively managing
risk instead of transferring it.

Risk retention is often part of a broader risk management plan that can include risk avoidance,
reduction, and transfer.

What is Risk Retention in Business?

In business, risk retention centers on the strategy of keeping certain risks internal rather than
transferring them externally, like to insurers. When an organization retains risk, it assumes financial
responsibility should an adverse event occur. This approach can be deliberate, focusing on potential
benefits versus potential drawbacks.
Why Businesses Choose Risk Retention

Understanding why a business might choose to retain risk is crucial. Here are some common
motivations:

 Financial Efficiency: Avoiding costly insurance premiums can result in significant savings.

 Better Risk Control: Firms can manage risk as they see fit, without insurer constraints.

 Predictable Risks: Frequent, low-impact risks might be cheaper to handle directly.

These factors collectively guide businesses in crafting their risk management strategies, empowering
them to weigh benefits against potential exposure.
A tech startup might decide not to insure its office equipment for minor damages, opting instead to
allocate funds for future repairs—a classic example of risk retention.

For larger corporations, risk retention becomes a sophisticated process involving self-insurance
programs. Such enterprises might set up captive insurance companies—subsidiaries created to
insure the parent company's assets. This strategy allows businesses to influence policy terms,
coverage scope, and premiums. Ultimately, this can enhance cash flow management and risk
evaluation internally, yielding long-term financial benefits.

Did you know? Many companies blend risk retention with other strategies like avoidance,
reduction, or transfer to balance their overall risk profile.

Understanding Risk Retention in Business Studies

When studying business, it's essential to understand the concept of risk retention. This strategy
involves a business deciding to keep certain risks rather than transferring them to external entities
like insurance companies. By retaining risk, a company accepts the potential financial impact should
an issue arise.
Reasons for Risk Retention

Businesses might opt for risk retention for several reasons:

 Cost Consideration: Paying for insurance can be expensive. By retaining risk, a company can
save on premium costs.

 Control: When a business retains risk, it can personally manage and mitigate the risk rather
than relying on an insurer to dictate terms.

 Predictability: Risks that occur frequently but with minor impacts often make retention a
preferable choice.

All of these factors help shape a business's overall risk management strategy, allowing it to balance
savings against potential risks.
Risk Retention: A strategy where a business accepts and manages risks within its operational
framework rather than outsourcing them.

Consider a small retail store that decides against insuring its inventory for minor theft. Instead, it
sets aside monthly savings to cover potential losses. This allocation is a pragmatic example of risk
retention.

Delving deeper, large organizations often adopt complex risk retention strategies, such as
establishing their own captive insurance companies. These are subsidiaries created to handle the
parent company's insurance needs, offering enhanced control over risk management. Captives can
provide financial advantages like premium savings, improved claim handling, and bespoke coverage
terms, which can outperform conventional insurance models.

Tip: Blending risk retention with strategies like risk transfer and reduction can create a balanced
approach to risk management.

Risk Retention Examples

Risk retention highlights how businesses choose to manage risks internally. To better understand
this concept, it's valuable to examine real-world examples.
Real-World Examples of Risk Retention

Businesses across various industries employ risk retention strategies to control costs and manage
specific risks directly. Here are some examples that illustrate the diversity of risk retention decisions:

 Manufacturing Company: A manufacturer may decide not to insure machines against minor
operational downtimes, preferring to maintain a reserve fund to address potential
disruptions swiftly.

 Retail Business: A small retailer might skip insuring its stock against minor damages, instead
using sales margins to cover potential losses.

 Tech Firm: A technology company might retain the responsibility for hardware maintenance
instead of purchasing a comprehensive warranty, choosing to rely on in-house expertise.

In the hospitality industry, a hotel might decide to self-insure against minor property damages
caused by guests. This example of risk retention allows the hotel to manage the cost of repairs
directly, freeing up funds that would otherwise go towards insurance premiums.

Exploring deeper into the concept reveals that risk retention can sometimes prove highly beneficial
in volatile industries. Take the oil and gas sector, where companies often retain environmental risk.
By investing in advanced safety technologies and training, they mitigate risks and potentially reduce
the financial impact of incidents. Over time, this can be a cost-effective strategy compared to relying
solely on insurance.

Risk retention - Key takeaways

 Risk retention refers to a strategy where a business or individual chooses to keep or accept
certain risks instead of transferring them to third parties like insurance companies.

 The definition of risk retention emphasizes the decision to bear the financial implications of
specific risks internally.
  Understanding risk retention involves evaluating factors such as cost savings, control of risk
management, and predictable low-frequency losses.

 Examples of risk retention in business studies include a bakery not insuring its delivery
vehicle and businesses creating self-insurance funds.

 Risk retention in business involves keeping risks internal, assuming financial responsibility
during adverse events, and managing them rather than outsourcing them.

 Real-world examples of risk retention include manufacturers not insuring against minor
downtimes, retail businesses foregoing stock insurance for minor damage, and tech firms
managing hardware maintenance in-house.

What are the advantages and disadvantages of risk retention in business?

Advantages of risk retention include cost savings from not paying insurance premiums and greater
control over risk management strategies. Disadvantages include potential financial strain from
unexpected losses and the need for sufficient capital reserves to cover retained risks.
How does risk retention impact a company's financial statements?
Risk retention impacts a company's financial statements by increasing liabilities or reserve
accounts, reflecting potential future obligations. It can reduce short-term profits as funds are
allocated to cover potential losses, and it affects cash flow management, as retained risks must be
funded internally without relying on insurance claims.
What factors should be considered when deciding on a risk retention strategy in business?
Factors to consider include the company's risk tolerance, financial capacity to absorb losses,
potential impact on operations, cost-effectiveness compared to purchasing insurance, historical
and industry risk data, and alignment with overall business strategy and objectives.
What role does risk retention play in a company's overall risk management strategy?
Risk retention plays a crucial role in a company's overall risk management strategy by allowing
businesses to intentionally keep certain risks, which they are prepared to absorb, due to cost
considerations, low risk probability, or potential benefits, ultimately helping optimize resource
allocation and focus on managing critical risks effectively.
What are some common examples of risk retention practices in businesses?
Common examples of risk retention practices in businesses include self-insurance, maintaining a
risk reserve fund, deductibles in insurance policies, and accepting minor or predictable losses as
part of normal operations to avoid the cost of transferring the risk to an external party.
Alternative Risk Management Strategies
Much focus of risk mitigation is about implementing controls: preventative, detective and
reactive. This is necessary in most cases, and continuous sustainment of those controls is critical,
but it is not sufficient.
 There are additional ways of reducing risk: inherent risk reduction (risk avoidance), threat
neutralization, and risk transference.

Inherent Risk Reduction

Avoiding risk by adjusting your reality. One of the, often forgotten, defender’s advantage is that
in many circumstances we control the landscape and we can adjust it in our favor. There are
many examples of this:
 Data minimization (eliminating data, not keeping data, anonymizing). It can be surprising how
business processes/supply chains can continue to work when certain data fields are removed -
and how much data propagation happens without intent in lazy table propagation.
 Attack surface reduction (reducing how much of a digital environment you present to
adversaries).
 Service heterogeneity and moving target defenses (trade-offs here of course, as some inherent
risk reduction here can spike other risks).
 Service dependency isolation.
Threat Neutralization (where threat in this context is broader than “attackers”)
Neutralize or deter threats by a range of organization, but mostly system-wide, activities from
legal and regulatory actions, societal norms, behavioral cues, education and deterrence. There
are tomes on deterrence, but for me it simply comes down to imposing actual or perceived costs
& adjusting the economics of attackers through penalty (consequences), futility (expense without
reward), dependency (self-damaging), counter-productivity (self-defeating).

Risk transference
In a world of Risk = Hazard + Outrage I don’t often see transference working as anything other
than a method of recouping costs and off-setting certain types of loss absorbing capital. In many
cases what is labeled as risk transference is simply shifting obligations, but the risk (accountability
and liability) often remains. Through the lens of transfer it seems there is a “Conversation of Risk”
law in place where risk is simply transformed, not reduced.
Finally, it’s worth talking about the other risk management strategy of risk acceptance. There is
always some residual risk, if not then you’re not looking hard enough. Some residual risk you
won’t accept & will work hard to fix, but some you’ll want or need to live with.

Residual risk should be within the defined risk appetite of the organization expressed
quantitatively and qualitatively of which a key component is deciding who at what level of the
organization can accept it. But, accepting risk is simply the beginning of that journey.
The 2 things most neglected in this are: developing a response plan should that risk actually be
realized and, most importantly deciding what triggers the revalidation of the risk acceptance. The
most common trigger is time e.g. review and (re-)accept risk every 6 months.
But there are more valuable triggers that change a stance on risk acceptance e.g. inherent risk
increases, change in threat landscape, legislative/regulatory changes, increase in risk events
outside or close-calls inside that call into question your likelihood ratings.

Hedging with Derivative Contracts

FUTURES AND OPTIONS
In the world of finance, risk management is a crucial aspect of maintaining stability and ensuring
long-term success. One of the most effective tools for managing risk is hedging, and derivatives
are often used for this purpose. This blog aims to explain the concept of hedging using
derivatives.
What is Hedging?
Hedging is a risk management strategy used to offset potential losses in one investment by
making another investment. Essentially, it's like taking out insurance to protect against
unfavorable market movements. The goal is to reduce the impact of price volatility and minimize
the risk of financial loss.

What are Derivatives?

Derivatives are financial instruments whose value is derived from an underlying asset, index, or
rate. The most common types of derivatives are futures, options, forwards, and swaps. These
instruments can be used to hedge against various types of risks, including price fluctuations,
interest rate changes, and currency exchange rate movements.

Why Use Derivatives for Hedging?

Derivatives are popular for hedging because they allow investors and companies to manage risk
without having to sell or buy the actual underlying assets. This provides flexibility and can be cost-
effective compared to other risk management methods.

Common Hedging Strategies Using Derivatives

1. Futures Contracts
What are Futures Contracts? Futures contracts are standardized agreements to buy or sell an
asset at a predetermined price on a specific future date. They are traded on exchanges, which
provide liquidity and reduce counterparty risk.
How to Use Futures for Hedging
  Hedging Commodity Price Risk: A farmer expecting to harvest wheat in six months can
sell wheat futures contracts now to lock in a price. If the price of wheat falls by harvest
time, the farmer's loss on the sale of wheat is offset by the profit from the futures
contract.
 Hedging Stock Market Risk: An investor holding a portfolio of stocks can sell stock index
futures to protect against a market downturn. If the stock market declines, the loss in the
portfolio is offset by the gain in the futures position.

2. Options Contracts
What are Options Contracts? Options give the buyer the right, but not the obligation, to buy (call
option) or sell (put option) an asset at a predetermined price before or at the expiration date.
The buyer pays a premium for this right.
How to Use Options for Hedging

 Protective Put: An investor holding a stock can buy a put option on the same stock. If the
stock price falls, the put option increases in value, offsetting the loss in the stock. This
strategy provides a safety net while allowing the investor to benefit from any potential
upside. For example, if an investor wants to buy a stock but thinks its price is currently
too high, they can sell a put option at their desired entry level (support) and can enjoy the
premium profit of the sell put. If the stock price falls to this level, they can exercise the
put option and buy the stock at the lower price, thus entering the position at a more
favorable price.

 Covered Call: An investor who owns a stock can sell a call option on that stock. The
premium received from selling the call option provides some income and can offset a
small decline in the stock's price. However, if the stock price rises significantly, the
investor may have to sell the stock at the strike price, potentially missing out on some
gains. For instance, if you own a stock and find it in a sideways market, you can sell the
same quantity of the holding as of the lot size. This way, you generate income from the
premium while waiting for the stock to move out of the sideways pattern.
What is the Black-Scholes Model in Options?
The Black-Scholes model, developed by Fischer Black and Myron Scholes in 1973, is a
mathematical framework for pricing European-style options. This groundbreaking model helps
traders and investors determine the fair price of options based on factors such as the underlying
asset's current price, the option's strike price, the time to expiration, the risk-free interest rate,
and the asset's volatility. By providing a standardized method for option valuation, the Black-
Scholes model has become a cornerstone in financial markets, enabling more accurate and
consistent pricing of options and contributing significantly to the field of financial engineering.
What are Greeks in Options?
The Greeks in options trading are metrics that help investors understand how different factors
affect the price of an option. They provide a way to measure the sensitivity of an option's price
to various influences, such as changes in the price of the underlying asset, time decay, and
volatility. The main Greeks include:

1. Delta (Δ): Delta measures the sensitivity of an option's price to changes in the price of the
underlying asset. For example, a delta of 0.5 means that the option's price is expected to
change by ₹0.50 for every ₹1 change in the price of the underlying asset.
2. Gamma (Γ): Gamma measures the rate of change of delta over time or as the underlying
asset's price changes. It helps traders understand the stability of delta and how it might
change with market movements.
3. Theta (Θ): Theta represents the rate of time decay of an option's price. It quantifies how
much the option's price will decrease as the expiration date approaches, all else being
equal. Options tend to lose value as they near expiration, and theta helps measure this
erosion of value.
4. Vega (ν): Vega measures an option's sensitivity to changes in the volatility of the
underlying asset. Higher volatility generally increases an option's price because it raises
the probability of the option ending in the money.
5. Rho (ρ): Rho measures the sensitivity of an option's price to changes in the risk-free
interest rate. For call options, a rise in interest rates typically increases their value, while
it generally decreases the value of put options.

3. Forward Contracts
What are Forward Contracts?
Forward contracts are customized agreements between two parties to buy or sell an asset at a
specified future date for a price agreed upon today. Unlike futures, forwards are traded over-
the-counter (OTC), making them more flexible but also introducing counterparty risk.

How to Use Forwards for Hedging

 Hedging Currency Risk: A company expecting to receive payment in a foreign currency

can enter into a forward contract to sell that currency at a fixed exchange rate. This
protects the company from unfavorable currency fluctuations.
 Hedging Interest Rate Risk: A company expecting to take out a loan in the future can
enter into a forward rate agreement (FRA) to lock in the interest rate. This ensures that
the company is not exposed to rising interest rates.

4. Swap Contracts
What are Swap Contracts? Swaps involve the exchange of cash flows or other financial
instruments between parties. The most common types are interest rate swaps and currency
swaps.
How to Use Swaps for Hedging

 Interest Rate Swaps: A company with floating-rate debt can enter into an interest rate
swap to exchange its variable interest payments for fixed interest payments. This helps
the company stabilize its interest expenses.
 Currency Swaps: A multinational company with revenue in one currency and expenses in
another can use a currency swap to manage exchange rate risk. By swapping cash flows
in different currencies, the company can better match its revenues and expenses.

Benefits of Using Derivatives for Hedging

 Risk Reduction: Derivatives help manage and reduce exposure to various types of risks,
including price, interest rate, and currency risks.
 Flexibility: Derivatives offer flexible solutions tailored to specific risk management needs
without requiring the sale or purchase of the underlying asset.
 Cost-Effective: Hedging with derivatives can be more cost-effective than other risk
management strategies, such as selling assets or buying insurance.

Risks of Using Derivatives for Hedging

 Complexity: Derivatives can be complex instruments requiring a good understanding of

how they work and their implications.
 Counterparty Risk: For OTC derivatives, there is a risk that the other party may default on
their obligations.
 Market Risk: Derivatives themselves can be subject to market risk, and poor hedging
strategies can lead to losses.

Conclusion
Hedging using derivatives is a powerful strategy for managing financial risk. By understanding
how to use futures, options, forwards, and swaps, investors and companies can protect
themselves against adverse market movements and achieve greater financial stability. However,
it's essential to approach derivatives with a clear strategy and a thorough understanding of their
risks and benefits.
By gaining expertise in these hedging techniques, you can make smart decisions that safeguard
your investments and ensure long-term success in the ever-changing financial markets.
https://www.investopedia.com/trading/using-derivatives-to-hedge-risk/

How Companies Use Derivatives to Hedge Risk

If you are considering a stock investment and read the company uses derivatives to hedge some
risk, should you be concerned or reassured? Warren Buffett's stand is famous: He has attacked
all derivatives, saying he and his company "view them as time bombs, both for the parties that
deal in them and the economic system...derivatives are financial weapons of mass destruction,
carrying dangers that, while now latent, are potentially lethal."1
On the other hand, the trading volume of derivatives has escalated rapidly, and non-financial
companies continue to purchase and trade them in ever-greater numbers.2
To help you evaluate a company's use of derivatives for hedging risk, we'll look at the three most
common ways to use derivatives for hedging.

Foreign Exchange Risks

One of the more common corporate uses of derivatives is for hedging foreign currency risk,
or foreign exchange risk, which is the risk a change in currency exchange rates will adversely
impact business results.
Let's consider an example of foreign currency risk with ACME Corporation, a hypothetical U.S.-
based company that sells widgets in Germany. During the year, ACME Corp. sells 100 widgets,
each priced at 10 euros. Therefore, our constant assumption is that ACME sells 1,000 euros
worth of widgets.
When the dollar-per-euro exchange rate increases from $1.33 to $1.50 to $1.75, it takes more
dollars to buy one euro, meaning the dollar is depreciating or weakening. As the dollar
depreciates, the same number of widgets sold translates into greater sales in dollar terms. This
demonstrates how a weakening dollar is not all bad: It can boost export sales of U.S. companies.
Alternatively, ACME could reduce its prices abroad, which, because of the depreciating dollar,
would not hurt dollar sales; this is another approach available to a U.S. exporter when the dollar
is depreciating.
The above example illustrates the "good news" event that can occur when the dollar
depreciates, but a "bad news" event happens if the dollar appreciates and export sales end up
being less. In the above example, we made a couple of very important simplifying assumptions
that affect whether the dollar depreciation is a good or bad event:

1. We assumed ACME Corp. manufactures its product in the U.S. and therefore incurs its
inventory or production costs in dollars. If instead, ACME manufactured its German
widgets in Germany, production costs would be incurred in euros. So even if dollar sales
increase due to depreciation in the dollar, production costs will go up too. This effect on
 both sales and costs is called a natural hedge: The economics of the business provide its
own hedge mechanism. In such a case, the higher export sales (resulting when the euro
is translated into dollars) are likely to be mitigated by higher production costs.
2. We also assumed all other things are equal, and often they are not. For example, we
ignored any secondary effects of inflation and whether ACME can adjust its prices.
Even after natural hedges and secondary effects, most multinational corporations are exposed
to some form of foreign currency risk.
Now let's illustrate a simple hedge a company like ACME might use. To minimize the effects of
any USD/EUR exchange rates, ACME purchases 800 foreign exchange futures contracts against
the USD/EUR exchange rate.
The value of the futures contracts will not, in practice, correspond exactly on a 1:1 basis with a
change in the current exchange rate (that is, the futures rate won't change exactly with the spot
rate), but we will assume it does anyway. Each futures contract has a value equal to the
gain above the $1.33 USD/EUR rate (only because ACME took this side of the futures
position; the counter-party will take the opposite position).
In this example, the futures contract is a separate transaction, but it is designed to have an
inverse relationship with the currency exchange impact, so it is a decent hedge. Of course, it's
not a free lunch: If the dollar were to weaken instead, the increased export sales are mitigated
(partially offset) by losses on the futures contracts.

Hedging Interest Rate Risk

Companies can hedge interest rate risk in various ways. Consider a company expecting to sell a
division in one year and receive a cash windfall it wants to "park" in a good risk-free investment.
If the company strongly believes interest rates will drop between now and then, it could
purchase (or take a long position on) a Treasury futures contract. The company is effectively
locking in the future interest rate.
Here is a different example of a perfect interest rate hedge used by Johnson Controls (JCI), as
noted in its 2004 annual report:
"Fair value hedges: The company [JCI] had two interest rate swaps outstanding
at September 30, 2004 designated as a hedge of the fair value of a portion of fixed-rate bonds.…
The change in fair value of the swaps exactly offsets the change in fair value of the hedged debt,
with no net impact on earnings."3
Johnson Controls is using an interest rate swap. Before it entered into the swap, it was paying a
variable interest rate on some of its bonds (e.g., a common arrangement would be to
pay LIBOR plus something and to reset the rate every six months). We can illustrate these
variable rate payments with a down-bar chart.
 Now let's look at the impact of the swap, illustrated below. The swap requires JCI to pay a fixed
rate of interest while receiving floating-rate payments. The received floating-rate payments
(shown in the upper half of the chart below) are used to pay the pre-existing floating-rate debt.
JCI is then left only with the floating-rate debt and has therefore managed to convert a variable-
rate obligation into a fixed-rate obligation with the addition of a derivative. Note the annual
report implies JCI has a perfect hedge: The variable-rate coupons JCI received exactly
compensate for the company's variable-rate obligations.4

Commodity or Product Input Hedge

Companies depending heavily on raw-material inputs or commodities are sensitive, sometimes
significantly, to the price change of the inputs. Airlines, for example, consume lots of jet fuel.
Historically, most airlines have given a great deal of consideration to hedging against crude-oil
price increases.
Monsanto produces agricultural products, herbicides, and biotech-related products. It uses
futures contracts to hedge against the price increase of soybean and corn inventory:
"Changes in commodity prices: Monsanto uses futures contracts to protect itself against
commodity price increases...these contracts hedge the committed or future purchases of, and
the carrying value of payables to growers for, soybean and corn inventories. A 10 percent
decrease in the prices would have a negative effect on the fair value of those futures of $10
million for soybeans and $5 million for corn. We also use natural gas swaps to manage energy
input costs. A 10 percent decrease in price of gas would have a negative effect on the fair value
of the swaps of $1 million."5

The Bottom Line

We have reviewed three of the most popular types of corporate hedging with derivatives. There
are many other derivative uses, and new types are being invented. For example, companies can
hedge their weather risk to compensate them for the extra cost of an unexpectedly hot or cold
season. The derivatives we have reviewed are not generally speculative for the company. They
help to protect the company from unanticipated events: adverse foreign exchange or interest
rate movements and unexpected increases in input costs.
The investor on the other side of the derivative transaction is the speculator. However, in no
case are these derivatives free. Even if, for example, the company is surprised with a good-news
event like a favorable interest rate move, the company (because it had to pay for the derivatives)
receives less on a net basis than it would have without the hedge.